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What Pension Benefit Election Is Best For You?

Planning for your retirement income is an important process with many moving parts. There are different income channels that you will need to account for like your investment portfolio, designated retirement accounts, Social Security, and your pension benefits. 

Pensions are talked about less and less due to the diminishing supply of pension opportunities in the private sector. But for those of you who will benefit from this avenue of retirement income, it is important to understand the options you have for receiving your money. 

Today, we are going to take a look at the top four ways to take your pension benefits. Keep in mind that some of these options may be more beneficial than others, it just comes down to how the strategy fits into your financial plan. 

1. Lump-sum payout

Once you retire, your company will give you the option to take your pension benefits in one lump sum. By cashing out your pension, you would receive all of the funds at one time.

At first, this idea may sound like the California gold rush. You’ll have an immediate increase in your financial resources and the autonomy to handle the money in the best way that you see fit. This could allow you to invest the money in other channels like an IRA, giving you more freedom in how your money is being invested.

But more often than not, a lump-sum payment isn’t like striking gold at all, turning out to be fool’s gold instead. While a lump sum does offer immediate autonomy and freedom, that comes with a real financial risk. Many people have trouble managing that large of a sum and end up losing more than they gain. 

A lump sum also increases the amount of money you have access to which can lead to more recreational and temporal spending. These habits can start to eat away at your retirement budget and savings plan that you have spent years cultivating. 

It is also important to look at the tax considerations with a lump sum. By taking the funds from your pension all at once, you will be responsible for paying ordinary income tax on the money. This tax consequence can eat away at so much of the money you have spent years working for. If you rolled the funds over into an IRA within 60 days, for example, you wouldn’t need to pay taxes until you started taking distributions on the money.

2. Single-life annuity

If you don’t take your pension in a lump sum, you will take it in some form of an annuity. An annuity is a promise of money to be paid overtime, and in the case of your pension, it will be lifetime payments made in monthly installments. There are many types of annuity structures for pensions and we are going to start with one of the most popular options, single-life annuity. 

A single-life annuity offers the highest monthly payment of all pension annuity options, making it one of the most popular among retirees. With a single-life annuity, you would receive the largest monthly check based on your package for the rest of your life. Many people gravitate to this option without fully understanding it. 

This annuity is structured to pay you each month but after you pass away your payments stop, leaving your spouse or any dependents without any payments. This could present a problem if your spouse is dependent on those monthly checks and will continue to need some of that support if you are gone. 

It is important that you include your spouse in the decision-making process. Together you can assess your other streams of retirement income, cash flow, and budget to make the right choice for both of you. 

3. Joint and Survivor options

Many married couples select a joint and survivor option in order to take care of the remaining spouse when the other passes away. This option is a great way to ensure your spouse will still receive payments when you are gone. These plans offer two main options: 50% and 100% of benefits. 

Your choice between these two will decide how much you get paid each month and the portion of that money that your spouse is entitled to if you pass away. Let’s take a look at both options in a little bit more detail

By selecting the 50% option, you will receive slightly higher monthly checks and when you pass away, your spouse would be eligible to receive half of your benefit. This option is great for couples who have multiple streams of retirement income. Take the hypothetical couple, Sam and Sandy as an example. 

Sam selects the 50% joint and survivor option and his monthly checks are $600. After 8 years, Sam passes away from health problems and under this plan, his wife, Sandy, will still receive $300 every month for the rest of her life, providing essential retirement income. 

Now, we will take a look at the 100% option. This plan will lower your monthly payments but it will allow your spouse to receive your full monthly benefit after you pass away. In the case of Sam and Sandy, this option would lower Sam’s monthly payments to $400 per month. But after passing away, Sandy would still get that same $400 per month. 

There is no perfect choice, rather the choice that makes the most sense for you as a couple. Retirement decisions are so important to make together and it is a good idea to think through your health, life expectancy, income sources, as well as your goals for retirement before making a choice. 

4. Period Certain options

The last annuity structure we are going to look at today is period certain options. This is another great way to take care of your loved ones. With this option, you will have a built-in guaranteed payout for a set number of years ranging anywhere from 10 to 20 years. 

Like all of the other annuities we talked about today, period certain options provide monthly payments for life and guarantee that same payment for your spouse or dependents for a set number of years. We will bring back Sam and Sandy to help illustrate this point. 

Sam is in average health but still expects to live a long time in retirement, leading him to select a period certain plan for 15 years. This option allows Sam to receive his full monthly payment as long as he is alive. If Sam were to pass away 12 years into the plan, Sandy would be eligible to receive Sam’s full benefit for the remaining 3 years of the plan. 

Like a single-life annuity, when the period is over, benefits end. If Sam outlived his plan by passing away in 17 years, the benefits would stop and Sandy wouldn’t be able to receive them. 

Pension in practice

Deciding how to take your pension benefits is a deeply involved process that moves beyond just retirement planning. It includes estate and legacy planning and doing your due diligence to support the loved ones that you leave behind. When selecting the best option for you and your family, think through the following:

  • Desired retirement lifestyle and the funds needed to support that

  • Create and stick to a retirement budget

  • Understand avenues for retirement income including changing cashflow

  • Make a tax planning strategy

  • Organize your estate planning strategy

  • Offer support to loved ones and dependents.

We are passionate about guiding couples to live the retirement they have worked so hard for. At Step by Step, we want to help you create a comprehensive retirement plan, designed just for you and your family. Are you interested in how your pension can impact your retirement income? Give us a call!