The 6% Rule: A Quick Screen for Lump Sum vs. Annuity

One division that cuts through the noise

You open the envelope from your former employer. Two numbers stare back: a lump sum of $500,000, or $2,500 a month for life. Which is the better deal? Before you build a spreadsheet, do one division. It takes ten seconds, and it tells you which side of the fence you are on.

The rule

Annualize the monthly pension payment, then divide by the lump-sum offer:

If the result lands at or above 6%, the annuity starts looking attractive. Below 6%, the lump sum looks like the better value, assuming you can invest it competently and live long enough for compounding to work. At exactly 6%, the math is roughly a wash, and the decision comes down to health, risk tolerance, and family circumstances.

Why 6% is the line

The logic rests on what money can reasonably earn. A balanced stock-and-bond portfolio has historically returned roughly 5 to 7 percent a year before inflation. A pension annuity is a guaranteed income stream, priced by actuaries using corporate bond yields, lately in the 4 to 5 percent range, plus a margin.

So the question the 6% rule answers is really: can I beat this guaranteed payment by investing the lump sum myself? If the pension implies a 7 or 8 percent yield on the lump sum, you would need stock-market-like returns just to match a guaranteed check, which is a bad trade for most retirees. If it implies 4 percent, a moderately invested IRA has a decent shot at beating it, and you keep control of the principal.

One planner's version of the same idea uses 7% as the threshold, noting that payout rates around 7% or higher are hard to replicate safely on your own when the standard safe withdrawal rate is about 4%. The exact line moves with interest rates, but the principle holds.

A second worked example

Say the offer is a $320,000 lump sum or $1,800 a month:

Above 6%, leaning annuity on pure math. Now flip it: $420,000 lump sum or $1,800 a month:

Below 6%, leaning lump sum. Same monthly check, very different answers, because the lump-sum side of the ratio moved.

What the rule does not capture

The 6% screen is a starting point, not a decision. It ignores several things that can flip the answer:

• Interest rate timing. Lump sums are discounted using IRS segment rates tied to corporate bond yields. When rates rise, lump sums shrink; the rate increases of 2022 to 2024 cut some lump-sum offers by 15 to 25 percent for the same monthly benefit. A low ratio in a high-rate year may say more about timing than value.
• Longevity. The annuity wins bigger the longer you live. Good health and parents who lived into their 90s tilt toward the annuity; below-average health tilts toward the lump sum.
• Inflation. Most private pensions do not adjust for inflation. A fixed $2,500 check buys less every year, while a lump sum invested for growth can at least try to keep up.
• Survivor needs. A single-life annuity ends at your death. If a spouse depends on that income, price the joint-and-survivor version, which pays less per month, and rerun the ratio.
• Employer health. Private pensions are backstopped by the PBGC up to about $7,436 a month at age 65 in 2026. If your pension exceeds that and the company is shaky, the lump sum removes bankruptcy risk.

The sanity check planners actually use

Here is a cross-check worth the phone call: get a quote for a single-premium immediate annuity from an insurer that pays the same monthly amount. If buying that check on the open market would cost more than the lump sum on offer, the plan's annuity is the richer deal on paper. If it would cost less, the lump sum is. It is the market's own verdict on your employer's math.

My take

I like the 6% rule because it forces the right first question: what yield is this pension actually offering me? Most people choose based on vibes, a big scary number versus a comforting monthly check. The ratio turns vibes into arithmetic. Then do the real work: run the break-even age, check the survivor options, and get a second opinion before the election deadline. Buyout windows are often 30 to 60 days, and that deadline pressure is exactly when mistakes happen.