by Christian Hudspeth, CFP®
Retirement day is coming ever closer, and you’ve received your pension benefit letter from your employer. You’re grateful to have a pension for retirement, but with this perk comes its own set of challenging questions that you and other near-retirees face:
- Should you take a pension giving you guaranteed monthly income for life?
- Should you have a survivor benefit for your spouse or dependents in case you die first?
- Should you skip the monthly benefits and instead take a lump sum of multiple hundreds of thousands of dollars?
What’s the best option? If only it were that easy! Because everyone’s situation is so different, the choice is entirely personal to you (risk tolerance), your financial priorities (needs), and your financial goals (wants).
Today we’ll talk about four major questions you need to ask yourself before choosing your pension plan. But before we get to those, let’s review some typical pension options.
The Most Common Pension Options: Annuities and Lump Sums
When you receive your benefit letter, there can sometimes be an exciting amount of hard-earned money for you waiting on the line. But before you can receive payment, you’ll need to choose how you will be paid. Here are the four most common pension options we see:
Single life payment: Also known as a “straight life annuity,” this is where the pension provider will pay you the highest monthly benefit until you die. The only catch is your benefits won’t continue to pay your spouse or dependents after you’re gone.
Single life with term certain: This annuity option pays a little less monthly than the single life payment but has a tradeoff. “Term certain” means if you die before the term ends (five or 10 years is common), it will continue to pay out for the remainder of the term to your beneficiaries.
Joint and survivor: This choice pays the smallest monthly benefit of the three with the advantage that it continues to pay your spouse a percentage of your benefit if you happen to die before your spouse. Joint and survivor options often come in three varieties: 50%, 75% and 100%. For example, if your pension with a 50% survivor option is paying you $4,000 per month and you die before your spouse, they’ll receive $2,000 per month for the rest of their life.
Lump sum: Instead of a giving you a monthly income payment like the annuity options mentioned above, pension providers can offer you a sum of money you may rollover into an IRA so you can invest the funds. Some providers offer a partial lump sum, a compromise where you can receive a set lump sum amount now and collect a reduced annuity payment each month going forward.
What’s best for you: Annuity Payments or Lump Sum?
To be prepared for your crucial pension decision, you need to be able to answer these four questions with confidence.
How much monthly income do you need to pay for your living expenses?
Will the annuity’s monthly benefit (along with your other income) be enough to cover all your household’s monthly expenses? What about uncommon expenses? If you needed several thousand dollars to pay for surgery, a new car, or an expensive home repair, would you be financially prepared?
If you choose an annuity option, you may need to save some of your monthly benefits over time to be prepared for these big-ticket expenses. Alternatively, you could opt to receive the lump sum so you’ll have more flexibility to invest or spend in case of anticipated needs, emergencies, or opportunities.
Who depends on your income? Will this pension income financially take care of your loved ones?
Could your spouse or others who depend on you financially afford to live in your home and pay for their lifestyle without your full pension if you were to die? Could they live on 50% of your pension?
These are important conversations to be having with your spouse and financial advisor. If you don’t have life insurance or enough assets and you choose an annuity that doesn’t pay a high enough monthly survivor benefit, your untimely death could force those who financially depend on you to make significant lifestyle cuts or live in poverty in some cases.
Will your pension income keep up with inflation or stay the same year after year?
You may find that your pension annuity pays for your needs today, but if your monthly benefit stays the same and doesn’t keep up with the cost of living (i.e. inflation), you could soon find yourself on a fixed-income boat struggling to stay afloat amid a rising sea of expenses.
This is a case where investing a lump sum or a partial lump sum into investments that outpace inflation could provide a lifeboat for your financial security.
Who do you want to leave your money to?
Do you want to leave an inheritance for your heirs to enjoy? What about leaving your money to a charitable cause that lives on?
A term-certain annuity may be an option if you have poor health and would like to have your pension pay heirs for the remainder of the term after you’re gone. Even better, forgoing an annuity option altogether and instead investing a lump sum within an IRA for the long term could offer more flexibility on where your money goes after your death as it allows you to choose any person or entity as your beneficiary.
The Pension Decision
Do you know the answers to these questions with confidence?
A good financial advisor with a skilled planning team can analyze your financial situation, build a financial plan, and show you several scenarios with a pension choice that:
- Fits your unique life goals and circumstances
- Generates sufficient monthly income for your needs
- Keeps up with the rising costs of living
- Avoids excessive income taxation each year, and
- Ensures your loved ones have financial security after you’re gone
Like the crucial Social Security decision, the pension decision is not one you can afford to take lightly. Choose poorly, and you may find yourself in the middle of retirement forced to choose between going back to work or selling your family home. But choose wisely, and you’ll be happily reminded of your pension only when it lands in your bank account. Cheers!
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*The information presented here is not specific to any individual’s personal circumstances. FMP Wealth Advisers is not providing investment, tax, legal, or retirement advice or recommendations in this article.
**To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
***These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.