How do Pension Election Options Fit Into a Financial Plan

How do Pension Election Options Fit Into a Financial Plan

April 02, 2018

If you’re vested in a defined benefit plan, you have an important decision to make: how to receive your pension payout after you retire.  

Choosing the payout option that’s right for you is incredibly important. It can often be the cornerstone of your retirement plan – and your decision about which payout option you select can be influenced by you and your spouse’s health, age, income needs, and additional income sources. 

The key is to review each of your options carefully and build a thorough financial plan that adequately incorporates your pension payout. 


Reviewing Your Pension Payout Options 

Most plans offer the option of a lump sum payout along with several annuity options, including a single life annuity, 50% joint and survivor, 100% joint and survivor (there could be other variations of the joint and survivor option) and life with 10 years certain. Knowing the pros and cons of each can help you make the best decision for your unique financial situation.  



Lump Sum Option 

When you choose the lump sum option, you will receive a one-time payment to be invested however you choose. Unless you choose to roll it into an IRA immediately, the entire amount will be subject to income tax rates. This can hurt – especially if your pension payout is significant.   

If you roll the payment into an IRA, the taxes will be deferred until you withdraw the funds. As with any IRA, you’ll be subject to the Required Minimum Distribution rule. This means that you’ll need to withdraw a certain amount each year starting at age 70 ½. 

If you receive your payout but are under the age of 59 ½, any funds you withdraw will be subject to a 10% penalty as well as income taxes. If you are able to roll this amount to a 401(k) and are not employed by the company for who the 401(k) is tied to, you can take withdrawals from this account at age 55 without penalty. However, regardless of the account in which this sum is held, at age 70½, you will have to take Required Minimum Distributions. 


When a Lump Sum May Work for You 

If you believe that you can out-earn the return on your pension payout, a lump sum might be in your best interest. Essentially, your various pension payout options are determined based on a fixed amount, an assumed interest rate, your age at retirement, and your earnings. However, every pension plan is a little bit different. If you feel your funds won’t earn enough interest in the plan, investing a lump sum may earn you a better return in the long run. 

However, as is the case with any investment, there’s a risk that your funds will underperform – which may or may not have you “beating” the interest you’d earn within your pension plan. If your investments outperform the pension payout, you could increase your purchasing power and have enough available to leave as a legacy for your heirs. It’s important to keep in mind that, depending on how you invest your funds, there may be investment management fees, which could impact the performance of your portfolio.  

Single Life Annuity 

A popular payout option is the single life annuity. This option guarantees lifetime monthly payments, which ensures a consistent income stream during retirement.  

When a Single Life Annuity May Work for You 

If you’re single, a single life annuity likely makes the most sense if you’re looking for lifetime income. After all, payouts are calculated using the length of your life as a measuring stick.  

However, if you are married, your decision is more complicated. If your retirement plan has other income options that can provide for your spouse in the event of your death, the single life annuity may still be right for you. However, if you believe you’ll need your pension payout to help provide for them – you might look into one of the other payout options available to you.  

Of course, strategic planning can help you to work around this predicament. You should always speak with a CFP® professional to fully understand all of your options. 



50% Joint and Survivor Option 

The 50% joint and survivor option is often a good option for retirees who expect their spouse to outlive them. This option ensures that your surviving spouse will receive half of your monthly payments after you pass away for the rest of their life. While this may not be a significant contribution to their retirement income, it can be helpful. 

However, keep in mind that this option’s monthly payout is lower than a single life annuity because there is additional risk of it being paid out longer to care for your surviving spouse. Typically, in a 50% joint and survivor option, your total monthly payout is reduced by a certain amount. For example, if single life option pays $2,800 a month, the 50% joint and survivor option might only pay $2,300 a month, but your spouse would receive $1,150 a month until he or she dies.  


When the 50% Joint and Survivor Option May Be Right for You 

You might choose the 50% joint and survivor option if your spouse is dependent on your pension income, and if you expect them to outlive youWhile this may not be fun to consider, it’s critical that you ensure both of you are taken care of financially through retirement. 

100% Joint and Survivor Option 

This option is similar to the 50% Joint and Survivor Option, but it adjusts the total payout upfront in order to offer your surviving spouse more in the event of your death.  

In other words: if you agree to a reduced payout, your spouse will receive 100% of that reduced amount after you pass away. Using the same example as above, if the single life payout is $2,800 a month, this payout option may be reduced to $2,100 a month to provide your spouse with $2,100 of monthly survivor benefit.  


When the 100% Joint and Survivor Option May Be Right for You 

The 100% joint and survivor option provides the greatest protection for your spouse, but it significantly reduces your payout – which isn’t a fantastic idea when you’re trying to plan a retirement income. However, if you expect your spouse to outlive you and you don’t have another income source, this may make the most sense for you.

  

Life with 10 Years Certain Option 

The life with 10 years certain option will make monthly payments for your lifetime but, should you die within the first 10 years, the payout will continue to your spouse for the remainder of the 10-year term.  

This option has the second highest payout behind a single life annuity, but it also offers the least amount of protection for your spouse.  

Sticking with the same example we’ve been using: If the single life payout is $2,800, the life with 10 years certain payout might be $2,550, which would be paid to your spouse at your death through the 10th year.  


When the Life with 10 Years Certain Option May Be Right for You 

The life with 10 years certain option might be suitable if you are likely going to outlive your spouse. It offers minimal spousal protection but has a high payout for a short period of time if the unthinkable happens and you pass away.  

Make Your Choice Count for Your Future 

You’ve spent years working for your pension but taking it without putting some thought into your payout plan is a mistake. Your pension has the opportunity to cover expenses for both you and your spouse for a long time – and by maximizing its value, you’re increasing your retirement income. 

If you have questions about your pension, I’d love to help. Set up an obligation-free consultation today, and we can discuss how a comprehensive financial plan can guide this decision and many others as you look ahead to retirement.