TL;DR: Choosing among pension options can have a lasting impact on your retirement income, taxes, spouse, and beneficiaries. This guide explains the major payout choices and the factors to weigh so you can make an informed decision based on your financial situation and retirement goals.
Main points:
- Compare pension annuity options: Learn how single life, joint life, and period certain payments differ in monthly income, duration, and survivor benefits.
- Evaluate monthly payments vs. a lump sum: Understand the tradeoffs between guaranteed pension income and taking control of your retirement funds.
- Explore rollover and tax strategies: See how rolling a lump sum into a traditional or Roth IRA may affect taxes and legacy planning.
- Consider your personal circumstances: Factor in health, longevity, spouse income needs, Social Security, required minimum distributions, expenses, and investment comfort.
- Choose based on your retirement goals: Discover why there is no single best pension choice for every retiree.
As a retirement option, pensions are increasingly on the endangered species list. Largely replaced with 401(k)s and other employee-managed accounts, pensions at one time were overwhelmingly popular.
Baby Boomers who worked between the 1960s and 1980s were often provided a pension for their retirement plan. These days, unless you’re a government worker or one of the lucky 15% of today’s employees, odds are you don’t have one.
One major pension vs 401k difference is how retirement income is managed. A pension generally provides benefits based on the plan’s payment rules, while a 401(k) leaves more investment and withdrawal decisions to the employee.
If you’re one of the fortunate few with a pension, you have a critical decision to make: which pension option should you choose? The right decision for your unique situation could mean the difference between a comfortable retirement or one plagued by high income taxes and lost funds.
What Are the Main Pension Annuity Options?
There are three ways to make your pension pay out monthly:
- Single life: Payments continue for your lifetime and usually provide a higher monthly amount. Payments generally stop when you die.
- Joint life: Payments continue for your lifetime, then a portion of the benefit continues to your spouse after your death.
- Period certain: Payments continue for a fixed number of years. If you die before that period ends, the remaining payments generally go to your named beneficiary.
If you don’t have a spouse, the single life option is likely your best choice. The payouts from single life tend to be larger than other pension annuity options because they only last over your lifetime.
If you have a spouse, you’ll want to make sure they’re financially stable after you pass. With the joint life option, you can make your payouts stretch over your lifetime and into your spouse’s. The amount of money paid to your spouse after your death is pre-arranged and is often about 50-75% of the original monthly payments.
This option is the default if you’re married, so if you want to select a single life payout, your spouse will have to sign paperwork to waive their benefits.
Your pension can also provide a monthly payout over a set number of years, which is called period certain. This will typically provide the largest monthly payment because there’s a clear end. People in good health who retire young could have many decades of single life payments, while people receiving period certain payments over 10 or 15 years know exactly when their benefits will stop. If the retiree passes away, the remaining payments are paid to the beneficiaries, usually a spouse or child.
Single Life vs Joint Life Pension
When comparing a single life vs joint life pension, it helps to look at several factors side by side:
- Monthly payment: Single life payments are often higher.
- Spouse protection: Joint life continues a portion of the benefit to your spouse.
- Payment duration: Single life ends at your death, while joint life can continue after your death.
- Beneficiary impact: Joint life may provide more income protection for a surviving spouse.
- Household needs: Your choice may depend on how much your spouse relies on your pension income.
The joint life option is often the default if you’re married, so if you want to select a single life payout, your spouse may have to sign paperwork to waive their benefits.
None of these monthly payment options can be stopped or adjusted, so make sure the combination of your required minimum distributions, Social Security benefits and pension payments won’t bump you into a higher tax bracket.
It’s wise to consider your current health and life expectancy to determine which type of payout will maximize your income. If you think you’ll live 15 or 20 years into retirement, a period certain plan might cause you to miss out on years of retirement benefits.
Should You Take a Lump-Sum Payment?
Rather than waiting for years to reap their full benefits, retirees can choose to receive their pension dollars all at once with the lump-sum payment option. The payment is based on your estimated life expectancy. With a lump-sum payment, you have full control and flexibility for spending, saving or investing those funds. Instead of keeping your company in charge of investing your pension dollars, you have the power and responsibility of investing.
There are certain risks to consider with a lump sum payment. If you tend to be a spender, monthly payments could help keep you in check, whereas a lump sum gives you the opportunity to waste your dollars on unnecessary expenses.
In addition, The Employee Retirement Income Security Act of 1974 (ERISA) provides extra protection and prevents pension payments from being misused by former employers, but taking a lump sum waives the protection of ERISA.
Despite owing millions in a civil judgment, O.J. Simpson still has a retirement plan from the Screen Actors Guild with $5 million and an NFL pension plan. If he would have taken a lump-sum payment, those funds wouldn’t be protected by ERISA.
What Pension Plan Rollover Options Are Available?
On the positive side, lump-sum payments can allow for a better tax strategy. You can use a Roth conversion to put your lump-sum payment into a Roth IRA, which could save you from being pushed into a higher tax bracket in the future. Plus, after-tax accounts, like a Roth IRA, save you from paying any taxes when you withdraw.
Converting your pension into a Roth or traditional IRA account allows you to create a legacy to pass on to your kids or other beneficiaries. With single or joint life payments, the pension stops paying as soon as the recipients pass.
How Should You Compare Pension Distribution Options?
As a financial advisor, clients often ask me what the best option is, but the truth is there isn’t one. The pros and cons of each option vary from person to person, and the best way to make your decision is to play out the potential scenarios.
Imagine what would happen if you pass away 20 years down the road, or even later, and acknowledge the outcomes of each situation. When comparing pension distribution options, consider factors such as:
- current health and expected longevity
- spouse’s future income needs
- monthly retirement expenses
- expected Social Security benefits
- required minimum distributions
- current and future tax brackets
- comfort with managing investments
- plans for leaving assets to beneficiaries
At Asset Preservation Tax & Retirement Services, we use our extensive experience with retirement plans to help our clients sort through the possibilities and choose the right options for their unique situations. I always tell my clients the choice simply boils down to making an informed decision based on the potential upsides and downsides.
Which Pension Option Is Right for You?
Be wary of listening to advice from friends or coworkers. Every person's health, desired lifestyle, risk tolerance and life expectancy are different. What’s right for one person might not be a good fit for you.
Avoid the watercooler talk and think through your personal situation without being swayed by the advice of others. After all, your retirement dreams are one-of-a-kind, be it relaxing at a beach condo or becoming a devoted community volunteer, and your retirement strategy should be just as unique.
Frequently Asked Questions
What is the best pension option to take?
The best pension option is the one that fits your income needs, life expectancy and family situation. Single life usually pays more each month, joint life can continue income to a spouse, and a lump sum gives you more control over the money.
What are the three options for a pension?
The three common pension options are single life, joint life and period certain.
- Single life: Pays for your lifetime.
- Joint life: Pays for your lifetime and continues payments to a spouse.
- Period certain: Pays for a fixed number of years and may continue to a beneficiary if you die early.
How much will a $100,000 pension pay per month?
A $100,000 pension does not have a fixed monthly payout. Your payment depends on your age, plan terms, interest rates and whether you choose single life, joint life or another payout option.
Your pension administrator can give you the exact monthly amount for each choice.
Is $70,000 a year a good pension?
Yes, a $70,000 annual pension can provide a comfortable retirement for many people. Whether it is enough depends on your expenses, taxes, housing costs, healthcare costs and other retirement income.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
