(Article by Janice Revell from Money magazine, July 2008)

A life of monthly checks usually beats a big fat lump sum.

If you're one of the lucky 30 million American workers still covered by a traditional defined-benefit pension plan, you'll likely be faced with a crucial and irrevocable decision when you retire: should you take your pension in the form of a guaranteed monthly check for life or should you grab all of your pension money up front and manage the funds yourself? The vast majority of retirees choose the lump sum - 90% of them, according to the Society of Actuaries. Before you join them, consider the risks.

As long as you end up living a long life, the monthly checks are the better deal. Let's say you retire at 65 and can collect a pension of $2,000 a month, payable for life, or a lump sum of $300,000, which you can roll over into an IRA (thus deferring taxes until you take withdrawals). If you choose the lump sum, the odds that you'll be able to generate the same $2,000-a-month income for the rest of your life hinge on how long you live and how good an investor you are.

A 65-year-old man has about a 50% chance of living to age 85; a woman has a 50% shot of getting to 88. If you live that long, you'll have to have earned an average annual return of 5.1% if you're a man, 6% if you're a woman, to produce $2,000 a month. (That assumes you draw down the lump sum to zero over your life span.) If you make it all the way to 95, you'll have to have earned 7% a year on average to match a pension check.

That may not sound like a bad bet, especially since over the past three decades a conservative retirement portfolio (40% stocks, 40% bonds and 20% cash at the outset, with a gradual shift to 10-70-20) returned about 7% a year. But keep in mind that those are long-term averages - your annual returns will fluctuate. If your investments take a big hit early in retirement and you keep taking out $2,000 a month, your $300,000 will run out long before you do.

How big is this risk? According to an analysis by T. Rowe Price, you have nearly a 30% chance of depleting a $300,000 lump sum by age 85, assuming you invest in a diversified stock and bond portfolio and withdraw $2,000 a month. Live to 90 and the likelihood hits 57%. As Oxnard, Calif. actuary Steve Vernon notes, "Not good odds for such an unpleasant outcome."

And furthermore

The case against the lump sum may be even stronger if you're offered a bigger monthly pension as an incentive for retiring early. About half of all companies don't factor that extra amount into the lump-sum calculation, says Vernon.

But wait

If most of your retirement income will come from your pension, the monthly checks pose a different set of risks. Once you choose them, you can't get at the lump sum. So, if you need a lot of money in an emergency, you're out of luck. Thus a better solution is to hedge your bets: choose the lump sum and buy an immediate fixed annuity with a portion of the money (this will give you a monthly check just like a pension) and invest the rest for growth. Go to immediateannuities.com to compare annuities from highly rated insurance companies.

Also consider the lump sum if you're in poor health. And think about it if you have a generous pension and fear your company might go bankrupt. The federal Pension Benefit Guaranty Corp. guarantees benefits, but currently up to only $4,312 a month.

You do the math

To see what you'd have to earn to make the lump sum generate the same income as a monthly pension, use the investment distributions calculator at dinkytown.net.

The bottom line

In most cases, the checks are the better choice. 

The risk of creating your own pension

Taking your pension in a lump sum and withdrawing the same amount you'd get via a monthly check works out fine at first, but as you age, your risk of depleting the funds shoots up.

Notes: Assumes a $300,000 pension and $2,000 monthly withdrawals; portfolio is 40% stocks, 40% bonds, and 20% cash; life expectancy is median (life expectancy of a 65-year-old man is 85; a 65-year-old woman is 88).
Source: T. Rowe Price