Pension Lump Sum vs Annuity: Discount Rate at $500K

The pension lump sum versus annuity election is one of the highest-stakes financial decisions most workers ever make, and the financial press routinely answers it badly. The standard advice (roll the lump sum into an IRA so you can control the money) misses the central question: at what implied interest rate does the pension annuity pay, and can you reliably earn more than that rate on the lump sum with comparable risk? For a 65-year-old male electing a $500,000 lump sum versus a $2,750/month single-life annuity, the implied IRR over a 25-year horizon is approximately 5.6 percent. In May 2026 with 10-year Treasury yields at 4.3 percent and investment-grade corporate bonds at 5.2 percent, the annuity beats most fixed-income alternatives mathematically.

This guide walks the present-value calculation, the IRC Section 7520 and Section 417(e) interest rates that determine the lump sum offer, the ERISA Section 205 joint-and-survivor annuity default for married workers, and the PBGC insurance backstop. The conclusion: for most workers in average health with a 50 percent QJSA election and a financially solid employer, the pension annuity is mathematically the better choice. The lump sum makes sense for specific scenarios (health flags, large existing portfolio, estate planning goals, distressed employer).

The implied discount rate: how to actually compare the offers

The pension annuity election is structurally identical to a SPIA purchase decision: you exchange a lump sum for a lifetime stream of payments. The question is whether the implied yield on that exchange beats your alternative use of the capital. The standard arithmetic:

• Lump sum offer: $500,000
• Annuity offer: $2,750/month single-life ($33,000/year)
• Implied yield (year 1): $33,000 / $500,000 = 6.6 percent. But this is just the first-year cash yield; the annuity continues until death.
• Implied IRR over 25 years (life expectancy 65 to 90): approximately 5.6 percent. This is the discount rate at which $500,000 grows to fund $33,000/year withdrawals and reaches zero at year 25.
• Implied IRR over 30 years (65 to 95): approximately 6.8 percent. Living longer pushes the implied yield higher because more total payments are received.
• Implied IRR over 20 years (65 to 85): approximately 3.9 percent. Dying earlier than expected pushes the implied yield lower; the lump sum would have been better in this scenario.

The decision turns on life expectancy. At age 65, the Society of Actuaries 2012 Individual Annuity Mortality Tables (revised for 2026) show:

• Male median life expectancy: age 86 (21-year horizon, implied IRR 4.6 percent)
• Female median life expectancy: age 88 (23-year horizon, implied IRR 5.1 percent)
• Joint household (male 65, female 63) median last death: age 91 (26-year horizon, implied IRR 5.9 percent)

For a typical couple, the joint implied IRR of 5.9 percent is the right comparison number. If you can reliably earn more than 5.9 percent on $500,000 with risk comparable to a PBGC-insured pension, take the lump sum. If your alternative investments yield less, take the annuity.

How the employer calculates the lump sum offer

Defined benefit plans use the IRC Section 417(e) segment interest rates and IRS-prescribed mortality tables to calculate lump sum offers. The 417(e) rates are published annually by the IRS in Revenue Rulings; the 2026 rates effective for distributions made in 2026 are:

• First segment (years 0-5): approximately 4.8 percent
• Second segment (years 6-20): approximately 5.1 percent
• Third segment (years 21+): approximately 5.0 percent

The plan calculates the present value of the projected pension stream using these segmented discount rates and the IRS Notice 2024 mortality table. The result is the lump sum offer. The structure has important implications:

• When interest rates rise, lump sums fall. A worker who received a $500,000 quote in early 2024 (when rates were higher) may receive only $440,000 today if 417(e) rates have moved up. The annuity payment is unchanged; only the lump sum equivalent shifts.
• When interest rates fall, lump sums rise. Conversely, a falling-rate environment inflates lump sum offers. The 2020 low-rate environment produced unusually large lump sums; the 2023-2024 rising-rate environment compressed them.
• The plan uses a single set of rates; your personal discount rate may differ. If you can earn 7 percent on alternative investments with comparable risk, the plan's 5 percent discount rate undervalues the lump sum from your perspective. You should take the lump sum. If you can only earn 4 percent, the plan's 5 percent overvalues it, and the annuity wins.

The IRC Section 7520 rate (different from 417(e); used for estate and gift tax calculations on private annuities) is also relevant for any private annuity arrangement; it is published monthly by the IRS and runs approximately 5.2 percent in May 2026.

The Qualified Joint and Survivor Annuity default

Under ERISA Section 205 and IRC Section 401(a)(11), defined benefit pension plans must offer a Qualified Joint and Survivor Annuity (QJSA) as the default form of payment for married participants. The QJSA pays the worker a reduced monthly amount during their life, then continues paying the surviving spouse a percentage of that amount (typically 50 percent, sometimes 75 or 100 percent) for the rest of the spouse's life.

The worker cannot elect a single-life annuity or a lump sum without the spouse signing a written waiver of the QJSA. The waiver requirements under IRC Section 417 are strict:

• The waiver must be in writing
• The spouse must consent on a form that meets IRS specifications
• The consent must be witnessed by either a notary public or a plan representative
• The waiver must occur within 180 days before the annuity start date
• The spouse must acknowledge that they understand the financial consequences (loss of survivor income)

The 50 percent QJSA typically reduces the worker's monthly payment by approximately 10 to 15 percent versus single-life. The 100 percent QJSA reduces it by 20 to 25 percent. The actuarial reduction reflects the longer expected payment stream (until the second death rather than the first).

Decision rule for married couples: the 50 percent QJSA is usually wrong because it drops the surviving spouse's income by half just as fixed expenses (housing, healthcare, food) do not drop proportionally. The 100 percent QJSA is usually right unless the spouse has independent income (a second pension, large IRA, or own Social Security) that already covers their essential expenses.

PBGC insurance and counterparty risk

The Pension Benefit Guaranty Corporation insures private-sector defined benefit pension plans under ERISA Title IV. If your employer's pension plan terminates due to bankruptcy or insufficient funding, the PBGC takes over benefit payments up to a statutory maximum. The 2026 maximum guarantee for a single-life annuity starting at age 65 is approximately $7,225/month ($86,700/year), with lower maximums for early retirement and joint-and-survivor elections.

For most middle-class workers, the PBGC backstop provides credit risk comparable to AAA-rated government obligations. For workers at financially distressed employers or in plans below 80 percent funded, the PBGC maximum calculation matters:

• Pension below PBGC max: full federal insurance backstop. Counterparty risk is minimal.
• Pension above PBGC max: the excess portion depends on continued plan solvency. If the plan terminates, the excess may be reduced or lost.
• Multi-employer plans: PBGC coverage is lower for multi-employer plans, with separate funding and benefit guarantee rules under ERISA. Workers in multi-employer plans should verify coverage levels independently.

For pensions well within PBGC limits at solvent employers, counterparty risk is not a reason to take the lump sum. For pensions above the limit or at distressed employers, the lump sum can convert pension credit risk into self-managed investment risk, which some workers prefer.

Worked example: $500K lump sum or $2,750/month annuity, age 65

Robert is 65 and retiring from a Fortune 500 manufacturer. His pension election form offers:

• Option A: Lump sum of $500,000 (rollable to traditional IRA)
• Option B: Single-life annuity of $2,750/month ($33,000/year)
• Option C: 50 percent QJSA of $2,475/month ($29,700/year), with $1,237/month to surviving spouse
• Option D: 100 percent QJSA of $2,200/month ($26,400/year), with $2,200/month to surviving spouse

Robert is married to Susan (age 63). Susan has her own pension worth $1,500/month plus her own Social Security at age 67 of $1,800/month. The couple owns their home outright and has $300,000 in additional retirement savings.

The implied IRR calculation

• Option A vs Option B: $500,000 lump sum vs $33,000/year. Joint median last death age: 91 (26-year horizon). Implied IRR: 5.9 percent.
• Option D vs lump sum at 100 percent QJSA: $500,000 lump sum vs $26,400/year guaranteed until second death. Implied IRR over 26 years: 4.7 percent.

The alternative investment yield

If Robert rolls $500,000 into a traditional IRA and invests in a 60/40 portfolio (60 percent VTI/VXUS equities, 40 percent intermediate Treasuries plus TIPS), his expected nominal return is approximately 6.5 to 7.5 percent annualized over a 26-year horizon, with significant volatility. The expected return exceeds the implied IRR on Option D (4.7 percent) by approximately 2 to 3 percentage points but introduces sequence-of-returns risk and behavioral risk.

The right call

For Robert and Susan, the analysis points to:

• Take the 100 percent QJSA (Option D) for the pension. The implied IRR of 4.7 percent is lower than his expected portfolio return (6.5 to 7.5 percent), but the pension provides a lifetime income floor that does not require investment management or sequence-of-returns risk management.
• Keep the $300,000 in additional retirement savings invested for growth and flexibility. Together with the QJSA, the $300K provides liquidity for emergencies, Roth conversion capacity in pre-RMD years, and estate value for heirs.
• The lump sum makes sense if Robert had no other retirement savings and wanted to control 100 percent of his retirement capital, or if his employer had a credit rating below investment grade.

When the lump sum wins: five scenarios

1. Terminal health diagnosis or strong family longevity history of early death

If Robert has a terminal diagnosis or strong family history of death before age 75, the implied IRR on the annuity drops below the alternative investment yield. The lump sum, even at a conservative 4 percent withdrawal rate, will outlive a 10-year annuity stream from a financial perspective. Take the lump sum, roll to IRA, and consider the inheritance value.

2. Distressed employer with high uninsured pension exposure

If the employer is in financial distress and the pension exceeds the PBGC maximum, the uninsured portion creates real counterparty risk. The lump sum removes that risk in exchange for sequence-of-returns risk on the rolled IRA. Worth doing when the employer's long-term solvency is questionable.

3. Large existing portfolio with no income gap

If Robert had $2 million in IRAs plus Social Security plus a spouse's pension, his essential expense floor would already be covered. The pension annuity would simply consume IRMAA bracket space year-after-year. Taking the lump sum and rolling to an IRA allows him to manage distributions to optimize IRMAA and Roth conversion outcomes. The flexibility is worth more than the marginal lifetime income.

4. Charitable estate planning goals

If Robert plans to leave the bulk of his estate to charity through a charitable remainder trust or qualified charitable distributions, the pension annuity provides no estate value (it ends at death). The lump sum, rolled to an IRA and used for QCDs during life plus a charitable remainder trust at death, provides both lifetime income and charitable impact. Worth doing for donors with significant charitable intent.

5. Lump sum offer is mispriced upward

In falling-rate environments (like 2020-2021), the 417(e) discount rates can produce inflated lump sum offers. If the implied IRR on the annuity is below 4 percent, the lump sum is overvalued from a personal perspective; take it. In rising-rate environments (like 2024), the calculation reverses: lump sums are deflated and annuities look favorable. Always run the implied IRR calculation against current alternative yields rather than relying on a previous quote.

The administrative steps: how to actually execute the election

• Request the pension election kit from the plan administrator 90 to 120 days before retirement. The kit includes the lump sum offer, all annuity options with QJSA percentages, and the spousal waiver forms.
• Calculate the implied IRR for each option using your assumed life expectancy. A spreadsheet with the IRR function or an online calculator (Bogleheads, Schwab pension calculator) suffices.
• Compare the implied IRR to your alternative investment yield. For a conservative fixed-income comparison, use the 10-year Treasury yield plus 50 basis points (currently ~4.8 percent). For a balanced portfolio comparison, use 6 to 7 percent. For a 100 percent equity comparison, use 8 to 9 percent.
• Verify PBGC coverage at pbgc.gov. Confirm your employer's plan is single-employer or multi-employer and that your annuity is below the 2026 maximum.
• Decide on QJSA percentage. For married workers, the 100 percent QJSA is usually correct. The 50 percent QJSA leaves the surviving spouse exposed.
• Execute the election form. Spousal consent (with notarization) is required for any election other than the default QJSA.
• If electing the lump sum, complete a direct rollover to an IRA. Do not take the lump sum as cash and roll it within 60 days. The plan must withhold 20 percent for federal tax on any cash distribution, requiring you to make up the 20 percent from other funds to complete a full rollover.

Key takeaways

• The pension lump sum versus annuity decision turns on the implied internal rate of return on the annuity, compared to your alternative investment yield. For a 65-year-old joint household, the implied IRR is typically 5 to 6 percent over a 26-year horizon at current 417(e) rates.
• Employer lump sum offers use IRC Section 417(e) segment interest rates and IRS-prescribed mortality tables. When market rates rise, lump sums fall; when rates fall, lump sums rise. Always run the implied IRR against current alternatives.
• ERISA Section 205 mandates the Qualified Joint and Survivor Annuity (QJSA) as the default for married workers. Spousal waiver requires written consent and notarization. The 100 percent QJSA is usually correct for married couples; the 50 percent QJSA leaves the surviving spouse exposed.
• PBGC insurance under ERISA Title IV provides AAA-equivalent credit on annuities up to approximately $7,225/month at age 65 for 2026. For pensions below the PBGC max at solvent employers, counterparty risk is minimal.
• Take the lump sum when: terminal health diagnosis, distressed employer above PBGC limits, large existing portfolio with no income gap, charitable estate goals, or when implied IRR is below 4 percent due to inflated lump sum from low-rate environment.
• Take the annuity when: average health, no other guaranteed income beyond Social Security, financially stable employer, PBGC coverage adequate, or when implied IRR exceeds 5 percent with limited alternative investment options.