How a Pension or Lump Sum Choice Can Affect the Rest of Your Retirement

Do you have a lump sum or pension decision upcoming or maybe one you’re about to make? Well, we’re gonna walk through the ripple effects, not just for that lump sum or pension decision, but the tax ramifications on your social security, on other aspects of your retirement, of making that decision and what you need to know before you make it.

Share your decision in the comments

Now, if you have this decision upcoming or possibly you’ve made the lump sum or pension decision already, I want you to go in the comments and let us know either what you chose or which direction you’re leaning. From our experience sitting with thousands of people over many, many years, we’re going to say, I’m to predict about 80 % of you have either chose the lump sum or are leaning in the direction of taking the lump sum. So let us know where you’re at. I’m curious how accurate our prediction is.

And while you’re down there, we put a link in the description box to a tax planning report that encompasses many areas of tax planning in retirement. It’s pretty comprehensive. If you think that would benefit you, feel free to click on the link and go get that report.

As always with our channel, our goal here is to communicate the concept so you can understand and you can learn and hopefully apply it yourself. And of course, if you want help, you can always reach out to us.

But we’re gonna look at married filing jointly brackets and we’re gonna look at a $900,000 lump sum or a $72,000 pension. So if you’re single or married, or have a different number than 900, or you have 900 but your pension’s a different amount, you’re thinking a single life pension or a joint pension, whatever those options are. That’s not important for the purpose of this video. The purpose of the video is to help you understand the concept so you can hopefully apply it to your own plan, or as I said, if you need help, reach out to us.

What we typically see in the oil and gas industry here in Houston

A couple of other things I want you to understand. So you may be wondering why I chose 72,000 to go with this $900,000 pension. Because we have a lot of oil and gas clients. Here in Houston, Texas, Exxon, Chevron, all the big companies as part of the compensation package to attract key talent, they’ll offer these pensions or lump sums, although I think they’re getting away from them in recent years.

So all I did was I took what we typically see somewhere around about 8 % of the lump sum as the pension. So now it’s important to understand you should do this math yourself because if you do… We’ve seen 5%, 6%, 7%, even higher than 8 % before. It just kind of gives you a relative understanding of the value of your pension compared to other pensions that may be offered by different companies in the marketplace.

So 8%, that’s a pretty good pension. It’s something that we see fairly often, somewhere between 7 to 8.5%. So I just want you to have that context. Now, second thing, we’re in an environment right now where interest rates are going down and they’re expected to continue to drop.

How interest rates influence lump sum values

So there’s something called the gap rate. So if you have a lump sum or a pension, you should talk to your provider, ask when your pension or lump sum gets priced, because as interest rates go down, your lump sum will go up, because all of this is nothing more than an actuarial calculation.

It’s an annuity. Some companies will actually retain the risk and keep all of this money in their coffers and pay you out a guaranteed lifetime income. And other companies will simply give this to an insurance company to provide you an annuity for the pension. But it’s an actuarial calculation.

So based on everyone that’s in—this is a defined benefit plan—based on the ages, the life expectancy, the expected rate of return on the portfolio, they calculate based on how much money you have, how old you are, how much income based on your life expectancy that they will provide. So when interest rates go down, that calculation enhances the lump sum.

Why timing matters when pensions are repriced

So point being, if you’re making this decision today or next week or next month, it may not be repriced. So this may not impact you at all. But if you have the choice of maybe deferring your retirement for three months or six months or nine or 12, it’s something to be aware of and go to ask, when does it get repriced because of interest rates go down and you’re leaning towards a lump sum? It may behoove you to work another three or six, nine months to get the higher lump sum.

Now, many of you may just be, you know what, Troy, I don’t care for another 30 or 40,000. I just wanna pull the ripcord and get out of here. And that’s fine too. It’s a personal decision. I just want you to know that.

It’s important to point out if you’re watching this video, maybe four or five years from now, that the opposite is true as well. When interest rates go up, your lump sum is going to go down. So back when, like a few years ago, when interest rates started climbing, we were on the phones with everyone that we knew that had a pension or lump sum decision to make to say, hey, this is the deal. When interest rates go up, your lump sum is gonna go down. So make sure you know that as well.

Okay, if you follow this channel for a long time, you know I can get into the weeds, especially when it comes to taxes. So I started to do that with this video, but then I kind of took a step back and let’s say let’s keep it high level, let’s stay to the topic at hand. And if we get a lot of good comments or this is something you guys want to learn more about, I can do some follow-up videos.

Comparing lump sum rollover vs. pension income

So we’re going to keep this simple. We have a decision to make. Take the lump sum or the pension. If you take the pension, you get $72,000 a year. And we’re going to say, hypothetically, $50,000 of social security.

Or if you take the lump sum, you’re gonna roll that over to an IRA and you’re gonna have the same social security. So the amount of your social security doesn’t change. The way it’s taxed will. So yes, you have to roll the lump sum into a retirement account because it is a qualified rollover.

So all of this money at the company, it’s actually not even in your account. It’s in a giant pooled account called a defined benefit plan and it’s a qualified account. So when your employer contributes to this lump sum on your behalf, they don’t pay taxes on that contribution. It’s deferred, they get a tax deduction.

So when you get it, you roll it over to an IRA and every dollar you take out is going to be taxed. Same thing as if you take the pension. When you receive that pension, it’s 100 % taxed at ordinary income tax rates for your entire retirement.

How tax brackets and buckets work

From a planning perspective, in order to understand the short-term and the long-term tax consequences of making this decision, you have to have a little bit of an understanding of our progressive tax system. So I’m going to make this very, very easy to understand. Don’t click off. Don’t go to sleep.

I’m going to make this easy. And it’s going to be a very powerful addition to your memory bank or to your knowledge base when it comes to taxes in this country.

What President Trump did back in 2016 as they passed the Tax Cuts and Jobs Act, it went into acts in 2017. It was recently extended as part of the one big, beautiful bill. Now, it’s supposedly permanent, but we all know it’s only permanent until another political party comes into office and they’re going to address the tax code the way they see fit.

So this is only going to be in place for we know 25, 26, 27 and 28. So we have four years here. Very well could go on longer, but we know at least four.

So we have a progressive tax system. Think of these as buckets. So this is very critical to understand. The biggest thing that they did when they passed the Tax Fets and Jobs Act and why you have such a tremendous opportunity from a tax planning perspective with your retirement today and over the next four years is they made these buckets much bigger. So they’re tax brackets, but I like to refer to them as buckets because it’s easier to grasp.

So here we are. We have a 10 % bracket or bucket, 12%, 22 and 24. These are the ranges of taxable income approximated. I just rounded.

So this one, the first $23,000 of income gets taxed at 10%. If you have one more dollar than 23, it goes into this bucket and that dollar gets taxed at 12%, up to 96. If you have one more dollar than 96,000, that dollar goes into this bucket and it gets taxed at 22%.

So if you have $98,000 of taxable income, 23 will be taxed at 10%. The difference between 23 and 96 will tax at 12, and that extra $2,000 of income will be taxed at this 22 % rate.

Now you also have a 24 % bracket, and this is important because I’m gonna compare this to when the tax cuts expire, you’ll see the comparison.

Also wanna point out as part of the One Big Beautiful bill, if you’re over the age of 65 or 65 and above, your standard deduction has increased to 46,700. So this is a big component. This is around for the next few years.

So the buckets get filled, your income gets taxed at the rate of that particular bucket. And then as we progress through the buckets, you get taxed at a higher and higher rate, hence a progressive tax system.

What tax brackets could look like after the tax cuts sunset

Now we’re gonna compare what the tax buckets are today to what they were prior to the Tax Cuts and Jobs Act. And we simply inflate them a little bit, because the tax brackets inflate over time, to show you what they very well could be in 2031, what an educated estimate is based on what they were prior to the tax cuts.

10%, 15, 25. So I only show you three buckets because we’re already at the third bucket before this one even gets to the fourth and we’re at slightly higher rate.

But here’s why these buckets are smaller and there’s a reason for it. This is where the opportunity is right now. You could have up to $394,000 of income under the current tax system, taxable income. So your actual income because of the standard deduction could be closer to about $440,000 of income.

You then take out your standard deduction, you’re still in the 24 % bracket. Whereas here, 219,000 taxable income and your standard deduction is much smaller. So you could actually only have about $242,000 of income and you’re already being taxed at a higher rate. So 440 versus 240.

So this bucket is significantly smaller than what the buckets are today and for the next four years. This is important when you’re making a long-term lifetime decision like a lump sum or a pension, because if you choose the pension, it is taxable income every single year.

So you have to understand what the tax impact is today and tomorrow of making that pension decision, if that’s the way you’re going to go, and how it impacts the other aspects of your portfolio and your social security. So do you have bond interest? Do you have a real estate? Do you have annuities? Do you have dividends? Social security, all of that will be impacted by the decision to take the pension.

And if you don’t take the pension, if you take the lump sum, then you have tax infestation in the retirement account because you rolled it over. Now you have required minimum distributions. So all of these decisions, they all have ripple effects throughout the rest of your retirement.

Some of you may play golf. So if you think about when you play golf, when the club face comes through the point of contact, it should be square and then you’ll hit it at your target. But if it’s just a fraction open or a fraction closed, because you’re operating at such high speeds, the ball could be 20, 30, 40 yards off target.

Same thing with sailing. Let’s say you’re charting a course and you’re just fractionally off and you’re going for two or three weeks. Well, if you’re fractionally off this way or fractionally off that way, you’re probably going to be hundreds of miles apart in regards to your destination.

So these decisions that you make in retirement, not just a pension or lump sum, but almost every decision you make, they send you on different directions and you have no idea most times what we find out, what we’ve experienced when people are trying to make these decisions, when they do them on their own, they have no idea the different possible directions and the significance of the decision, how far it could set them on a different path.

How pension income affects social security taxation

Okay, now we’re gonna look at the tax analysis. So here we have pensions of 72,000 and then gross social security of 60. So I know I wrote 50 on the board earlier, but what I did is I told the team $5,000 a month, 60,000, that equals two times 12 months. And when I was coming in here preparing, I wrote 50,000 and got that mixed up with five, but it doesn’t change anything. The point’s still gonna get across.

So 72,000 of pensions, 60,000 of gross social security. Now, if you see here, it says gross social security of 51,000. That’s because only up to 85 % of social security is subject to taxation.

If you’d like to learn more about that, just released a video entitled, this is how to make your social security tax-free. Go through the calculation. It’s like everything tax-related is pretty complex, but I make it pretty easy to understand. So check that video out if you have not already.

So here’s the situation. Of taking the pension, not the lump sum. You have this. This is a guaranteed flat lifetime income. Typically they’re not inflation adjusted unless maybe you work for a government, federal or state. Most corporate pensions are gonna be just flat. And then social security is an inflation adjusted income.

So right now, 2025, the taxable portion of social security plus the pension comes to 123. You’re looking at a total tax of 8,679. If you take the pension, and we have the higher standard deduction. So you see here 34,000 plus the enhanced senior deduction, 12,000. That’s how you get to 46,000.

So take the pension, 86,000, 79,000 is your tax liability right now. Now I just want to show you if you don’t take the pension, you take the lump sum and you roll it over into a retirement account. I just want to show you the impact on your social security.

Of course, you’re going to have to figure where you get your income from, but this is where a lot of the variables in planning come. How many non-qualified assets do you have? Is your spouse working? I just want you to understand the relationship between pensions, lump sums, making those decisions, and for this instance, the taxation of your social security.

2025/2031 tax comparisons

So we have total income of zero. Now, does that mean you actually have no income? No, you have $60,000 of social security income. But because social security is preferentially taxed, it’s a preferentially treated source of income, on paper, you have zero income, your adjusted gross income is zero. You still have your standard deductions. You don’t get a credit when you go negative with your deductions, but your total tax is zero. Your total income on paper is zero.

Now, fast forward to 2031 here, looking at the smaller buckets, assuming the current tax cuts go away. We have 123,000 of income. So I did not inflate the social security income, because I’m trying to keep this as apples to apples as possible and just showing you the impact of the smaller buckets and the higher rates, how that impacts the Social Security income, or excuse me, the taxes.

Total tax, 12,083. So previously it was 86.79 with the bigger buckets and lower rates today. So this is about a 40 % increase to the annual tax liability.

And of course, this doesn’t take into consideration any other sources of income like IRA distributions, real estate, annuities, dividends, interest, anything like that.

Same thing, smaller tax buckets, no pension, we took the lump sum, just isolating the impact of the lower buckets on your social security. Same situation, total income zero. So on paper, even in the smaller buckets and the higher rates in the smaller standard deduction, because social security is preferentially treated, you still have $0 in total tax liability.

How pensions act as a net in the tax code

So I’m not telling you to always take the lump sum. I’m trying to help you understand that if you take that pension, what happens is you end up permanently in a state of taxation because no matter where we’re at in the bucket system, if you have a $60,000 pension, this bucket is automatically filled up. This bucket then partially gets filled up.

But what happens is in the tax code, when you have pensions, when you have IRA distributions, they act as a net. What I mean by that is that like a fisherman, he casts the net out, brings it in, he catches some fish. Well, in retirement with different sources of taxable income, when you have those like pensions or IRAs, it’s like a net that casts out and it starts to drag social security into a state of taxation. It starts to drag your dividends and interest into a, or your dividends at least into a higher state of taxation.

It can even increase your Medicare premiums, can increase the net investment income tax. It can trigger various thresholds of means testing throughout the tax code that essentially brings or actually brings more of your income into a state of taxation.

Additional planning options with a lump sum rollover

Now, I want you to feel like you have options and it’s not just the option of taking the lump sum or the pension. So let’s say we take the lump sum and we roll it over, what are some of our options? Well, we don’t have to with that IRA because it went into the IRA, we don’t have to always be in a permanent state of taxation.

We can make some proactive decisions today to maybe convert some of that over to raw. We don’t have to convert the whole 900,000 retirement account. Let’s say we do half of it, but then we break it up over a series of a couple of years. So 225 and 225. Or maybe we do it over four years, or maybe we do it over 10, or maybe we play it by ear.

We get to a point where we’re pretty comfortable with our balance between tax-free Roth IRA money and normal IRA money, then see what happens in the next election, what taxes are gonna be then.

If the taxes stay the same, you can continue to incrementally convert. If taxes are gonna go up, hey, maybe you just stop there, depending on your personal circumstances. Maybe you create a private market pension. So all the pension is from your company is an annuity. So maybe you consider a private annuity with a portion of that, and then you convert that private annuity to tax-free. So now you have the same benefit of a lifetime income, but instead of being taxable and filling up all of your buckets, now it’s a tax-free income.

You have a lot of different choices here. Literally, if you get into the minutiae, millions and millions and millions of choices.

A lot of people will like to do, let’s say you take the pension, okay? If you have that stability with the pension and the social security, and you don’t really care about the tax impact too much, well, a lot of people then will be very aggressive with the investment portfolio because that’s plenty of income. They don’t plan on touching that.

The goal here is to help you understand the impact of different decisions. Remember the golf analogy or the sailing analogy? Your circumstances are unique. You have different levels of income and assets and goals. All of that matters and all of that changes the potential direction of the decisions that you’re making today.

Why visibility is essential for retirement planning

But that’s why looking at it and understanding it is the most critical part of retirement planning. It’s not just how you feel today. It’s how is this decision that I’m making today impacting me now and in the future. We call it visibility.