Before you take the lump sum, work out what the pension pays

Quick answer: Divide the yearly pension by the lump sum. That percentage is what the plan is offering you. Then ask whether you could safely pay yourself that much from the lump sum for as long as you and your spouse will live. If you can't, the pension is probably the better deal, and you should say no to the big check.

The number you can see wins too often

A letter shows up with two offers. Take $2,400 a month for life, or take $380,000 now.

Nobody has ever felt rich looking at $2,400. $380,000 feels like a truck, a paid-off roof and a little left over. That's the pull, and the plan's actuaries know it.

Everything below uses made-up round numbers. They're worked examples, not forecasts. Your plan's figures will differ, so use your own.

Step one: get both offers in writing

Ask the plan administrator for a written benefit estimate with every option on it. You want:

• The single-life monthly amount.
• The joint-and-survivor amounts, at each percentage the plan offers (50, 75 or 100 percent).
• The lump-sum figure, and the date it's calculated as of.
• Whether the pension has any cost-of-living increase.
• Whether retiree health coverage depends on which option you pick.

That last one trips people up. Some employers tie retiree medical to the monthly pension. Ask before you assume anything.

Also ask how the lump sum is figured. It's generally built from interest rates and mortality tables set by rule, so when rates are higher the lump sum tends to come out smaller for the same pension. The same pension can be offered as a noticeably different check depending on the year you retire. Ask your plan how its number is set and whether the date matters.

Step two: find the payout rate

Our example: $2,400 a month is $28,800 a year. Divide by $380,000. That's about 7.6 percent.

Now picture yourself taking the check, rolling it into an IRA and drawing $28,800 a year. How long does it last? Rough math, assuming steady yearly returns and ignoring taxes:

• At 4 percent a year, the money runs out in about 19 years.
• At 5 percent, about 22 years.
• At 6 percent, about 27 years.

Retire at 65 and you're out of money somewhere between 84 and 92. Plenty of people live past that.

Real markets don't hand out steady returns, either. A bad first three years while you're withdrawing hurts far more than the same bad years later on. The pension doesn't care what the market does. That's what you're paying for when you give up the check.

Many planners suggest a first-year withdrawal rate nearer 4 percent for a retirement that could run thirty years. At 4 percent, our $380,000 supports about $15,200 a year. That's roughly half of what the pension pays. In this example the pension is doing a lot of work.

That's not always how it falls. If the plan's offer works out to a 5 percent payout rate and you have other secure income and long-lived money, the lump sum can be the stronger choice. The point is to know the rate before you decide.

Step three: read the fine print on the pension

Three things move the math.

Survivor benefits. The single-life amount stops when you die. If your wife depends on that income, taking it means betting she'll never need it. A joint-and-survivor option cuts the monthly check, perhaps from $2,400 to $2,150 in our example, but it keeps paying her after you're gone. Married couples are generally required to get spousal consent to skip the survivor option, for good reason. Take that seriously.

Inflation. Many private pensions have no yearly increase. At 3 percent inflation, $2,400 a month buys what about $1,330 buys today after twenty years. Real pensions with no raise lose ground quietly. A lump sum you invest has the chance to grow, and the risk that it won't. Weigh both.

The sponsor. A private-sector pension is generally backed by the PBGC up to limits that change every year, so check PBGC.gov for the current ones. Government pensions work differently and aren't covered by the PBGC. If the employer is shaky, or the plan is badly underfunded, that matters. If it's a state or a solid company, it matters less.

Step four: understand what a rollover does to taxes

Pension checks are taxed as ordinary income when you receive them. A lump sum moved by direct rollover into an IRA isn't taxed until you take money out.

Take the check made out to you instead and the plan is generally required to withhold 20 percent for federal tax. If you're under 59½ you may also owe a 10 percent early-withdrawal penalty. Get a direct rollover or don't take the lump sum at all.

Once it's in an IRA, every dollar you spend is taxable, and where you pull from first has consequences. This piece on which retirement account to spend from first covers the order.

Step five: build the floor, then decide

Add up the bills you can't skip: housing, food, utilities, insurance, property tax, Medicare premiums. Now add the income that doesn't depend on markets: Social Security, for you and your wife, and any pension. If that income covers the essentials, you have a floor. Anything the lump sum can offer sits on top of it.

If the floor has holes, the monthly pension is often the cheapest way to fill them. A steady check that can't be outlived does what a pile of money can't. That's not a sales pitch for any product. It's what the pension already is. If someone suggests you take the lump sum and buy an annuity with it, read what to ask before you sign an annuity contract first. Know what you'd be giving up and what it costs.

The lump sum has real advantages:

• It passes to your heirs. Money left in an IRA goes to your beneficiaries. A single-life pension ends at death. Make sure your beneficiary forms are current, because your will doesn't control most of your money.
• It's flexible. You can spend more early if you're healthy and active, and less later.
• It's yours if the employer fails. That's a risk you take on by leaving the pension.

Be honest about your own habits. Can you leave $380,000 alone while it sits in an account? Will you resist the family member with a business plan, the boat, the "investment opportunity"? Some men can. Plenty can't, and a monthly check is a fence that protects you from your own best intentions.

Before you sign

The decision is usually permanent. Once you take the lump sum, there's no going back.

Run your own numbers with the plan's actual figures. Check current limits and rules at IRS.gov, SSA.gov and PBGC.gov, because ages and thresholds change. Then sit down with a fee-only fiduciary adviser, who's paid by you and not by a product commission, and a CPA who can model the tax side. If your estate is complicated, add an estate attorney.

This is general education, not advice for your situation. The right answer depends on your health, your wife's, your other income and how well you sleep.

Pick the offer that still looks good in year twenty-five, not just the one that looks biggest on the day the letter arrives.