Pension Calculator
Compare a defined-benefit pension's monthly payments for life against a lump-sum buyout offer, both converted to today's dollars using your own discount rate.
How to use this calculator
- 1Enter the monthly pension amount and the lump-sum offer you are actually being given.
- 2Set the years you expect to receive payments and a discount rate — your realistic expected investment return if you took the lump sum instead.
- 3Add a cost-of-living adjustment only if your specific pension actually has one; most private-sector pensions do not.
How the calculation works
PV = Σ [monthly payment in month m] ÷ (1 + monthly discount rate)^m, for m = 1 to years × 12- monthly payment
- The pension amount, growing by the COLA percentage at the start of each year
- monthly discount rate
- Annual discount rate ÷ 12
- m
- Month number, from 1 through the total number of months
This is a discounted cash flow — the same principle behind the Present Value and Annuity calculators, applied month by month so a cost-of-living adjustment can be layered in without needing a separate closed-form formula.
The lump sum's monthly equivalent uses the standard loan-payment (annuity) formula in reverse: how large a payment a given amount of money can sustain over a fixed number of periods at a fixed rate.
Worked example
$2,000/month vs a $300,000 lump sum, 20 years, 6%
- 1.Discounting $2,000 a month for 240 months at 6%/12 = 0.5% monthly gives a present value of $279,161.54 — less than the $300,000 offer.
- 2.Checked the other way: $300,000 invested at 6% and drawn down over 20 years supports $2,149.29 a month, more than the $2,000 offered.
- 3.Both framings agree: at these assumptions, the lump sum is worth more than the pension.
Result: Lump sum ahead by $20,838.46 in present-value terms
Defined-benefit vs defined-contribution, in one sentence
A defined-benefit pension is a promise: the employer commits to a specific, formula-based monthly payment for the rest of the retiree's life, and the employer bears the risk of funding it — if the pension's investments underperform, the employer (not the retiree) is on the hook to make up the shortfall. A defined-contribution plan, like a 401(k) or IRA, is the opposite arrangement: the employee owns the account, and how much it is ultimately worth — and how long it lasts — depends entirely on markets, contributions, and the employee's own withdrawal decisions. This calculator's comparison is fundamentally a question of whether to keep the first kind of arrangement or convert it into the second.
Why employers offer lump-sum buyouts at all
A pension is a long-tail liability that sits on an employer's books for decades, exposed to interest-rate risk, investment risk and the risk that retirees simply live longer than actuarial tables assumed. A lump-sum buyout offer lets the employer remove that liability entirely in exchange for a one-time payment, calculated using the employer's own actuarial assumptions and discount rate. That last detail matters: the size of the offer is a direct function of what discount rate the employer chooses to use, which is why a buyout offer is not automatically a generous one — it is worth checking what the offer implies about the assumed rate, exactly as this calculator does by finding what discount rate would make the two options equal.
What present-value math leaves out
Comparing a pension's present value against a lump sum answers a narrower question than "which is worth more" — several real factors sit outside that comparison entirely.
- Longevity risk — a lifetime pension cannot be outlived by definition — it keeps paying regardless of how long the recipient lives. A self-managed lump sum can run out if the retiree lives longer than planned for, or if withdrawals are too aggressive.
- Inflation protection — a pension with a genuine cost-of-living adjustment protects purchasing power automatically; a lump sum has to generate that same protection through investment returns, with no guarantee it will keep pace.
- Spousal and survivor options — many pensions offer a joint-and-survivor election that continues paying a reduced benefit to a spouse after the retiree's death — a feature a simple single-life comparison like this one does not capture.
- A government insurance backstop — in the US, private defined-benefit pensions are insured up to a legal limit by the Pension Benefit Guaranty Corporation (PBGC) if the employer's plan fails; a self-managed lump sum carries no equivalent government protection.
- Investment discipline — a pension pays out automatically every month regardless of market conditions or personal spending discipline — a lump sum requires ongoing, correct decision-making to replicate that same reliability.
Why defined-benefit pensions have become rare
Since the 1980s, most private US employers have shifted away from defined-benefit pensions toward defined-contribution plans like the 401(k), largely because DC plans shift investment and longevity risk onto employees and are far more predictable for an employer to fund and budget for. Defined-benefit pensions remain considerably more common in the public sector — government and unionized employment — than in private industry today, which is part of why a private-sector worker facing this exact lump-sum-vs-pension decision is now the exception rather than the rule.
What this assumes, and where it stops
Assumptions
- The discount rate holds steady for the entire period — a single number stands in for decades of real, variable investment returns.
- Payments stop after the entered number of years, matching the classic single-life pension structure rather than a joint-and-survivor option that could pay a spouse afterward.
Limitations
- This is a math comparison, not financial advice — it ignores taxes (a lump sum rolled into an IRA defers tax differently than pension income), the pension's own inflation exposure without a COLA, and the value of a guaranteed income stream that a self-managed lump sum does not provide.
- Doesn't model the risk that a self-invested lump sum could earn less than the discount rate — or more. The comparison is only as good as that one assumed number.
- A traditional pension is typically insured up to certain limits by a government body (in the US, the PBGC); a self-managed lump sum carries no such backstop.
Common questions
Should I always take the option with the higher present value?
Not automatically. A guaranteed monthly income for life has real value beyond its present value — it can't be outlived, and it removes the risk of managing a large sum yourself. Some people rationally accept a lower present value for that certainty. Use this as one input to the decision, not the whole decision.
What discount rate should I use?
A conservative, realistic expected return for how you would actually invest the lump sum — not the most optimistic number you can imagine. Many advisors use somewhere between a high-quality bond yield and a diversified portfolio's long-run average, since a lump sum meant to replace guaranteed income is usually invested cautiously.
Why does a small change in the discount rate move the answer so much?
Because you're discounting cash flows decades into the future, and compounding is exponential — a 1-point change in the rate compounds differently over 20-plus years than it would over 2. It's worth testing a couple of rates on either side of your best guess rather than trusting a single number.
Formula and content last reviewed on .
Results are estimates for information only, not professional advice.
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