A pension can be an integral source of income in retirement. But there are many different ways to collect your benefit. How you receive that money can set the tone for your financial stability in your golden years.
When it comes time to retire, you will need to select how you would like to receive your pension benefits. Today, we are going to talk about the four main ways of securing your pension payments, their pros, and cons and how to make the right choice for you.
One option that you have when you retire is to cash out your pension. This would allow you to receive the full balance of your pension in one lump sum.
At first glance, this option may seem like winning the lottery jackpot. You will have an immediate influx of cash, bolstering your balance sheet and giving you the freedom to manage and control the funds in the best way you see fit. A lump-sum payment option can give you the flexibility to invest your retirement savings in other channels like an IRA, offering more choices on your investments.
But a lump-sum payout doesn’t always live up to the hype. By having such a large sum of money at one time, you may be more inclined to engage in recreational or temporal spending which can harm your retirement budget. Creating and adhering to a spending plan in retirement is an important way to keep your personal finances on track.
While one benefit of a lump sum is the flexibility and freedom to invest the money in any way you want, this same trait can also present a big roadblock. You now become responsible for managing, maintaining, and investing a rather large amount of money. This often proves to be difficult for many, leaving people anxious and stressed.
Another important factor to consider is the tax implications of a lump-sum payout. Should you simply take the lump sum and deposit it into a bank account you would be responsible for paying ordinary income tax on the money which would be an enormous tax burden. If you roll the funds into an IRA, however, you wouldn’t need to start paying taxes on the money until you start withdrawing funds, which can be as late as 72 with the new changes from the SECURE Act.
2. Single-life annuity
If you aren’t going to receive your pension payout in one lump sum, you will choose a type of annuity instead. An annuity is a product designed to pay you overtime. While there are many different types of annuities for pension plans, one of the most common and simplest is the single-life annuity.
A single-life annuity offers the recipient the highest monthly payout for their remaining life. This option is quite popular due to its consistency and high monthly payments. Many people gravitate toward this option without fully understanding how it works.
While you will receive the most lucrative annuity payout structure, those payments only apply to you. When you pass away, the monthly checks stop which could leave any dependents in a tough spot.
Be sure that you talk with your spouse or any dependents, assess your other retirement income streams, as well as your current and future cash flow planning to determine if this option makes sense for you and your family.
3. Joint and Survivor options
In lieu of the single-life annuity, many married couples elect to enroll in joint and survivor options. While offering less money per month, this annuity allows for continued financial support of your loved ones after you pass away. A joint and survivor plan often provides two choices:
- 50% of monthly benefits
- 100% of monthly benefits
Your choice will determine the amount you will receive each month and how much your spouse or dependent will be entitled to when you pass away. Let’s take a look at these options in a little bit more detail.
By choosing the 50% option, you will receive slightly higher monthly payments and your spouse would get half of that payment for the rest of their life should you pass away. This is often a great option for married couples that have additional streams of income. We can look at a hypothetical example to help.
Mark and Mandy are a newly retired couple and Mark elects to enroll in a 50% joint and survivor annuity. His monthly payments are $1,000. After 10 years Mark passes away and with this plan his wife Mandy will receive a $500 check for the rest of her life, providing vital retirement income.
The other option is 100% of the benefits. By enrolling in this plan, you will receive slightly smaller monthly checks, but your spouse or dependent would be eligible to receive your full monthly benefit after you pass away.
In the case of Mark and Mandy, should Mark have enrolled in the 100% plan his monthly payments would be reduced to $800 per month. But if Mark passes away, Mandy would be able to get that same $800 per month for the remainder of her life.
Neither option is perfect, it just comes down to your current and future retirement income channels, both you and your spouse’s pension plans, as well as other retirement benefits like Social Security. Spousal benefits are often an important part of retirement planning. Be sure to work with your spouse and financial planner in tandem to select the right option for you and your family.
4. Period Certain Options
Period certain options are another way to plan for your spouse’s future needs. With this annuity, you will have a built-in guaranteed payout for a set number of years. Many plans allow you to choose anywhere from 10 to 20-year options.
This option operates in the same way as any other annuity, offering consistent monthly payments for life and extending that same monthly payment to your spouse or dependent for a set number of years. Let’s bring Mark and Mandy back to illustrate this concept.
Mark is in good health and has a history of longevity and therefore selects a period certain 20-year annuity. This will allow Mark to receive his full monthly payment for the rest of his life. Should Mark pass away 15 years into the plan, Mandy would be the new recipient for the full monthly check for the remaining 5 years of the plan.
It is important to know that once the time frame is over, the payments stop. So if Mark outlived his 20-year plan, he would still receive monthly checks, but upon his passing Mandy would not be eligible for the payments.
Here are some things to consider about period certain options:
- Life expectancies
- Income needs
- Survivor benefits
The Bottom Line
While there are many different options for your pension payout, it all comes down to your retirement goals and lifestyle. Determining the right move for you and your family comes down to a few key elements:
- Understanding your retirement plan
- Creating and sticking with a retirement budget
- Knowing your current and future revenue streams
- Adhering to a tax planning strategy
- Legacy planning and making a plan for your wealth after you are gone
- Supporting your spouse and dependents
Working with a financial planner can help ensure you take the time to think about all of the factors that go into your pension payout. We love working with pre-retirees to help them create a financial plan that will give them the retirement they want and deserve. Give us a call today—we can’t wait to hear from you!
Stay tuned for the next part of our series coming in just a couple of weeks. See you then!