Lump Sum Case Study

The Pension Series (Part 11) : Pension Lump Sum Case Study

Pension Lump Sum Case Study

Hello! If you are a ChooseFI listener who made their way here to read my response to a ChooseFI listener’s pension question in Episode 58R, you’re in the right place! You can probably skip the Context section and go straight to the case study if you want. Also, if you’re one of the many listeners and readers who reached out to me as a result of my interview in Episode 57, thank you. I’d like to thank Jonathan and Brad as well for providing me the opportunity to spread the Golden Albatross message!

Pension Lump Sum Case Study
ChooseFI … it does what the label says.

On the other hand, if you have no idea what I am talking about, read the context portion. I wrote it just for you…

Context Is Key

Pension Lump Sum Case Study
There’s Jonathan and wife (I assume).

In late 2017, Jonathan Mendonsa and Brad Barrett from the ChooseFI podcast interviewed yours truly. It proved a great experience. When the episode aired on 08 JAN 2018, it generated a lot of traffic to my blog, FaceBook (FB) group, and FB page. It turns out though, that my interaction with Choose FI listeners was destined for more than one interview and intermittent responses in the ChooseFI FB group to pension questions. Jonathan and Brad asked me to joint their team as the resident researcher for pension questions based on my pension “expertise”. I guess pickings were slim when it came to bloggers who write about Financial Independence (FI) and Pensions! I didn’t have enough happening in my life between my family, military career, and blog; so I said “yes”.

There’s Brad and family. I hope he’s feeling better.

They didn’t waste any time either. I caught my first listener question on Christmas weekend 2017 .. with a due date of 12 JAN 18. They asked for an answer before their weekly round up episode, in which they review what they learned from the week’s interview and answer listener’s questions. Of course, that was the intended week of my interview, so it played into the overall theme of pensions for the week. I was happy to provide. Unfortunately, Brad got sick during the week of 12 JAN, so they pushed my listener question and answer to Episode 58R on 19 JAN 18. No big deal, we got there in the end.

Pension Lump Sum Case Study
Grumpus Maximus in the wild.

Thus, this post is the written version (with better grammar) of the same pension lump sum case study I read out loud on ChooseFI Episode 58R. You can find Tess’s (the listener’s) seemingly simple question at 38m53s into the episode, and my long winded response immediately following. You’ll need to at least listen to her question to understand my response.

Right onto my overly complicated answer to Tess’s question.

The Set Up

Whether or not a person should take a pension lump sum is the pension question I see asked most often in the ChooseFI FB group. As a result, I hope this proves an enlightening discussion for a portion of ChooseFI listeners.

Tess asked a seemingly simple question for which no simple or precise answer exists. To paraphrase in terms I use on my blog, Tess wants to calculate the Total Dollar Value (TDV) of her three different pension options in today’s dollars in order to compare them to her company’s lump-sum offer (also in today’s dollars).

One of the reasons there is never a precise answer to the TDV question is due to the vague nature of all retirement planning. Most importantly none of us know how long we will live! Nor do we know exactly what our rate of return or inflation rates will be. Thus, the clear mathematical answer Tess desires is an estimation at best, and a guess at worst.

Dude .. I just showed you my picture. There’s no way this Gorilla will fit in there.

Pension Lump Sum Framework

Since some estimations are better than others, it’s best to understand what we are dealing with, so let’s discuss some general facts about pension lump sums in order to frame our discussion.

Why do private pension funds, or any pension fund for that matter, offer lump sums? I will tell you it’s not out of the goodness of their hearts. No, pension funds offer lump sums primarily because it allows them to transfer risk at a discounted rate to the pensioner.

In other words, the company transfers the future risk of running out of money with which to pay the pensioner over to the pensioner in the present day. By taking a lump sum the pensioner incurs the risk of running out of money in the future, not the pension fund. Assuming the pensioner actually invests the money (a big assumption in my opinion), the pensioner runs the risk by not employing an appropriate Safe Withdrawal Rate (SWR) and therefore withdrawing all their money prior to death. As ERN McCracken has written about prolifically; employment of a SWR can be a tricky thing if an investor does not understand the facts and math.

The U.S. government further incentivizes the risk transfer from company to the pensioner with its rules that govern pension lump sum calculations. Most importantly, the rules allow companies to use what an article at calls “unrealistically high rates of return” for a lump sum invested by the pensioner. Higher than normal rates of return from an invested lump sum (again assuming the lump sum gets invested at all) forces the pensioner to reach for returns to achieve the same value that an annuitized payout would offer.

No surprise there …

The U.S. government also forces companies to use the government’s longevity estimates which inexplicably combines male and female longevity into one table. This is unfair to women offered lump sums since U.S. women statistically live longer than men. Conversely, for U.S. males, this unfairly bumps up their lump sum offer.

Since companies are legally allowed to “low-ball” their pensioners, TDV calculations almost always end up greater than the pension lump sum offered. Thus, anyone looking to compare a lump sum payout to the future value of their annuitized pension using today’s dollars should brace themselves. In rare cases, inflation mitigates this effect, but that isn’t the norm in my experience. If Tess wants a good article explaining these issues further, she can go to the article by William Baldwin (not the actor) I reference above. The article also provides a calculator which (supposedly) mitigates the flaws in U.S. based lump sum calculations and offers a true lump sum calculation.

Pension Safety

The final factor to understand up front in any lump sum discussion is pension safety. Pension safety is something of a trump card (no pun intended) when it comes to lump sums. If a high likelihood of pension fund failure exists, then no matter how “low-ball” the lump sum offer, a pensioner will probably take it.

“Danger Will Robinson, Danger!”

That said, pension safety is an area many people, including many of the ChooseFI Facebook followers, tend to misunderstand. Much of the advice I see in the ChooseFI FB Group generally equates to “assume your pension won’t be there for you, and if it is, it’s just icing on top of the cake”. If that were true, then logic should dictate that everyone take the lump sum offer.

But it’s not true. Each pension fund is run and managed separately from one another. To say that all pensions are doomed is not only inaccurate, but unhelpful to those trying to use a pension to help them achieve FI.

Thus, I would advise anyone in Tess’s situation to dig into the financial details of their pension fund. Pension funds and the companies that own them are required to produce annual statements and reports which disclose how well funded the pension fund is. If for some reason Tess cannot find those reports for her particular company, then I would recommend she go to Boston College’s Center for Retirement Research and see what information they have among their reams of reports on pensions. By doing this, someone should be able to build a much better estimate of the likelihood that their pension fund might fail in the future.

For a private pension, let me further point out that all may not be lost even if the pension fund fails. Many private and union pension funds in the U.S. belong to the Pension Benefit Guarantee Corporation (PBGC). The PBGC is a U.S. Government-backed insurance scheme meant to act as the final backstop for all pension funds who are paying members. However, the PBGC itself is massively underfunded and in need of much reform, which limits its usefulness. Currently, if the PBGC assumes the financial liabilities of a failed pension fund it only pays out about 60% of what is owed to a pensioner.

Don’t worry, they got about 60% of your back.

Facts and Assumptions

So with that long-winded framing of Tess’ question out of the way, let’s discuss the important facts and assumptions about Tess’ pension and lump sum offer:

  • We’ll assume Tess is asking about herself, not a spouse, and use female life expectancy rates
  • We know Tess’s pension is a private pension since she mentioned a company
    • No details on which company, so no ability to judge pension safety or if it’s a U.S. company
      • We’ll assume the pension is safe, and the company is U.S. based

      No ability to judge if the company’s a member of the PBGC

      • We’ll assume it is a member; although it doesn’t matter for this scenario
    • No ability to judge if the company’s a member of the PBGC
      • We’ll assume it is a member; although it doesn’t matter for this scenario
  • No survivorship consideration (as relayed via email)
  • No mention of a cost of living adjustment (COLA)
    • We’ll assume there is no COLA, which means inflation is at play
    • We’ll assume a 2% annual rate of inflation for all calculations
  • I didn’t see in the email or hear in the voice mail (VM) about any other pension benefits like healthcare
    • We’ll assume there are none
  • Tess is 48 (according to follow-up email) so has 7, 12, or 17 years to wait until pension payouts start; depending on which choice she makes
    • Assuming no COLA, that’s 7, 12, or 17 years of inflation eating away at the value of her payouts before they start
    • This means the value of the different monthly payouts offered ($690, $1066, and $1254) would respectively be worth $601, $841, $896 in today’s dollars when those payouts start. I made those calculations with this inflation calculator at
    • Finally, since Tess’s pension doesn’t start immediately, she needs to understand the Immediacy Effect as discovered and described by Big ERN McCracken in his 17th article of the Safe Withdrawal Rate Series
      • It’s worth a read, but I’ve yet to figure out how to value the immediacy effect mathematically for TDV calculations


Oh yeah, it’s just like that.

Right, I’m ready to make the TDV calculations now. Here’s how I do it for a situation like Tess’s. Take the inflation-adjusted monthly payouts I noted above, and turn them into annual amounts. Then multiply the various totals by the number of years left from the start point of each pension payout to the end of Tess’s assumed life. Finally, adjust that total again for inflation using the calculator. That should provide three different TDV’s in today’s dollars to compare the $75.5K lump sum.

Scenario #1 Age 55 Pension Pay Out

  • $601 x 12 months = $7212 per year
  • $7212 x (83 – 55 years) = $201,936 non-inflation adjusted cash value
  • $201,936 adjusted for 2% inflation over 28 years (83 – 55 years) =
    • $115,987 TDV in 2017 dollars

Scenario #2 Age 60 Pension Pay Out

  • $841 x 12 months = $10,092 per year
  • $10,092 x (83 – 60 years) = $232,116 non-inflation adjusted cash value
  • $232,116 adjusted for 2% inflation over 23 years (83 – 60 years) =
    • $147,198 TDV in 2017 dollars

Scenario #3 Age 65 Pension Pay Out

  • $896 x 12 months = $10,752 per year
  • $10,752 x (83 – 65 years) = $193,536 non-inflation adjusted cash value
  • $193,536 adjusted for 2% inflation over 18 years (83 – 65 years) =
    • $135,506 TDV in 2017 dollars

Comparison of TDVs to Lump Sum Offers

Wahay, we did it! Not only did we determine today’s TDV for Tess’s future pension payouts, but we also discovered that Scenario 2 provides the most money over her life expectancy (if our assumptions hold true). About this point is where I typically caution readers to remember the TDVs are at best estimations! Tess actually has to make it to 83 years of age to realize this scenario. Not only that, but she has to die (sorry Tess) at 83 for this to hold true too. Finally, our 2% inflation rate has to hold true over the lifetime of our scenario as well.

Those are a lot of assumptions, and they don’t include any of the other assumptions I made about Tess’s pension due to a lack of information. For instance, the addition of other pension benefits like healthcare, or a major pension safety concern, seriously complicates comparing a TDV to a pension lump sum. If that happens to be anyone else in the audience, then refer to Part 8 of my Pension Series for more detailed comparison methods.

However, in Tess’s case let’s assume everything is true up to this point and holds true throughout the lifetime of our TDV scenarios. As a result, I would recommend she concentrate on the difference between Scenario 2 and the lump sum offer. That comparison truly highlights the “low-ball” effect I described towards the beginning of this response. Tess’s lump sum offer is worth approximately half of what she’s owed in Scenario 2. Not good, but that’s what the U.S. law allows.

“Yoooou are an 18 year old girl who lives in a small city in Japan”. OK, that’s a Weezer song. I’ve no proof that Financial Samurai actually lives in Japan.

One last point worth noting, my method isn’t the only one out there for calculating pension lump sums. Both Financial Samurai and Actuary on Fire also wrote fairly extensive posts on how to value a pension. Actuary’s is probably the easiest, as it makes a lot of assumptions, and uses the XNPV function on MS Excel. Actuary’s method and mine are conceptually similar since we both base our calculations on the potential amount earned, discounted for inflation. Financial Samurai uses a Rate of Return method for comparing the value of a pension, which is something I don’t do. This illustrates the point I was trying to make at the beginning of this post though. Since there is no precise method for calculating TDV for a pension, there is no one correct method.


At this point, it’s over to Tess for her determination as to what to do. The TDV estimates argue for Scenario #2, but then again that doesn’t take into account what’s going on her personal life. As Airmen Mildollar likes to say, personal finance is personal; which means no two pension lump sums comparison scenarios will be the same. And as Brad Barret likes to point out on the ChooseFI podcast all the time, people value different things as well. All I’ve done is arm Tess with knowledge by showing her a way (not the way) to estimate her pension’s Total Dollar Value (TDV). She can use that knowledge to compare it to her lump-sum offer, but what she chooses to do with that knowledge is up to her. Best of luck Tess!

Post Script

I like doing these. If you’re interested I can run a TDV, pension lump sum, or FI pension scenario for you. I will emphasize I am neither a math genius, nor a trained professional though. However, anyone can learn to make these calculations; they just don’t necessarily have the time. The only “payment” I ask for in return is the permission to anonymize the data, and publish it as a case study article! Your call.

8 thoughts on “The Pension Series (Part 11) : Pension Lump Sum Case Study”

  1. GM- I’m being Mr Proofreader here- in the “Context” section you have the interview date as 2017. You have it correctly later but thought you might want to know. Keep your great content coming!

    1. Thanks ArmyDoc. You even beat my mother to the punch. Need a job as an editor? I’m serious. My sometimes editor travels and works.

  2. GM – are the private sector “lump sum” pension distributions generally allowed to roll into a tax deferred vehicle like an IRA? Or would the pensioner taking a lump sum have a big tax hit in the year the lump sum was taken?

    1. Army Doc,

      During my research into the Pension Lump Sum article, I saw references to some pension plans allowing the lump sum to roll into 401Ks and traditional IRAs. However, I did not research how wide spread that practice is or what determines when a lump sum can be rolled into a tax deferred account.



  3. Thank you Grumpus. I was wondering if you can go through the same way of figuring for an annuity? I was talked into putting $50k into an annuity after my husband died in2009. If I wait until I’m 73( 60 now) it will give me $1000/ month for life and any left over goes to my kids. If I close it now I think month.
    It sounded similar to me.

      1. Grumpus, as of October I don’t have any penalty for surrendering. As of the end of 2017 the lump sum would be $66,889.58
        On 8/2020 the Protected withdrawal value would be $100,000. Double that on 2030.
        My grand kids call me…Grumsie

Let me know what you think!