The aging population and the pressure on the sustainability of the public pension system led the Government of Pedro Sánchez to approve an ambitious reform underpinned by a clear yet complex objective: to increasingly delay the effective retirement age. And it did so through two avenues: penalizing early retirement of workers and rewarding those who choose to continue working beyond the legal age. However, one of the formulas chosen to encourage delayed retirement has a catch, since, for various reasons, retirees end up giving up a significant part of their future pension.
This is the so-called “lump sum payment”. A lump sum check offered by Social Security to those who retire after the legal age. Voluntarily, retirees can also opt for a permanent increase in their monthly pension for life (an additional 4%) or choose a combination of both formulas. The truth is that interest in receiving the money in a lump sum has grown significantly, since if in 2023 18.5% of delayed retirees chose the lump sum or mixed payment mode, in 2024 the percentage rose to 24%, with more than 21% choosing only the lump sum payment.
What compensates more? The reality is that the reward for delaying retirement is halved if paid as a lump sum instead of month to month. Therefore, there is no actuarial neutrality, a concept that implies that the money Social Security delivers in a lump sum should have exactly the same updated financial value as the total monthly pension payments the worker gives up during the remaining years of their life.
This is the conclusion of a report prepared by Fedea that evaluates 280 representative profiles combining different pension levels, genders, retirement ages, delayed years, and contribution careers, using mortality tables differentiated by income level. The fundamental conclusion is clear: the legal lump sum formula is not actuarially neutral in any of the profiles analyzed. That is, all workers who opt for the check instead of the lifelong pension increase suffer a financial penalty.
Specifically, the study determines that the lump sum represents, on average, only 51.2% of the actuarial value of the surrendered lifelong pension. This means that, in strictly financial and actuarial terms, the average worker who chooses the lump sum loses approximately 48.8% of the economic value of their incentive compared to receiving the 4% monthly increase. In other words: opting for the check means giving up practically half of the value of the pension they would receive throughout retirement.
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Greater gap in women and high pensions
For the authors of the study, these results raise “a relevant distributive issue,” since the gap is wider for women because their greater longevity increases the expected value of a supplement received for life, while the legal lump sum payment does not incorporate that difference. Additionally, it increases with the pension level: the capital formula grows less than proportionally, while the permanent supplement maintains a more direct relationship with the pension. Thus, two people with the same delay can receive lump sums representing very different proportions, depending on their gender, expected longevity, and pension amount.
Even in the most favorable scenario proposed by the authors, the lump sum received in a single payment at retirement remains lower than the value of the lifelong supplement. Nevertheless, the report concludes that retirees who choose to receive the check are not necessarily making a bad decision. In fact, the capital can be attractive “to meet immediate needs, pay off debt, invest, leave an inheritable amount, or reduce exposure to future changes in pension rules,” explain Fedea.
The study proposes “reviewing the calibration of the lump sum payment to reduce systematic differences and strengthen information at the time of choice.” “Useful communication should show, alongside the capital, the alternative monthly supplement, its estimated actuarial value, and the horizon from which the lifelong option accumulates more payments,” it notes. Thus, the authors do not recommend eliminating flexibility, but they do conclude that an irreversible decision between present liquidity and lifelong income “requires understandable comparisons and a formula whose lack of neutrality is explicit.” “Public policy can respect heterogeneous preferences and, at the same time, avoid design silently steering choice toward a less valuable option,” they conclude.
