As retirees approach their golden years, understanding the different options for collecting a pension is crucial.
This blog will provide a comprehensive guide to the best options for retirees to collect their pensions.
The Mechanics of Traditional Pension Plans
Pension plans are an employee benefit where the employer makes regular contributions to a pool of funds set aside for eligible employees after retirement. The most common type of traditional pension plan is a defined-benefit plan.
If an employer offers a defined-benefit plan, they guarantee qualified employees will receive a specific monthly payment after they retire and for life. This payment will be given to employees regardless of the growth of the investment pool. If the funds within the plan cannot pay out all of the benefits, the company is liable to cover the remainder of the cost.
Defined-Contributions plans differ because the employee contributes to the pool of funds that may or may not be matched by their employer. In addition, the final amount paid to employees is determined by the investment performance of the funds within the plan. The last significant difference is that the company isn’t liable to cover any remaining payout once the funds are gone.
If this concept sounds familiar, it’s because it is! The best-known type of defined-contribution plan is the 401k.
Let’s compare the two to see a defined-benefit plan’s incredible advantages fully.
|Specifies how much retirement income an employee will receive when they retire
|Employees receive an unknown amount at retirement
|Employer contributions aren’t capped at 25% of pay
|Employer contributions are often capped at 25% of pay
|No limit to the annual contribution
|Per person annual contribution limit
Lump-Sum vs. Monthly Payments
Those that receive a defined-benefit plan typically have two choices when it becomes time for their distributions. The options are monthly or lump-sum payments (all at once). But make no mistake, this decision can have high stakes because you cannot change your distribution method once you decide.
If you choose monthly, you have an additional choice of a single-life annuity for the employee only or a joint-survivor annuity for the retiree and their spouse. The main difference is that with a single-life annuity, the pension payout stops when the employee dies (a death benefit is paid to the surviving spouse). Joint-survivor annuities continue until the employee’s spouse dies, but they typically pay about 10% less each month.
If you take a lump-sum payment, you can further invest the funds and allow them to grow continually. Should there be any money left over when you die, you can include it as part of your estate. The downside is that you must create a withdrawal strategy to last through your retirement years. And your lump-sum amount will immediately be taxed and could push you into a higher tax bracket (unless you roll the amount into an IRA or other tax-deferred account).
Pension Maximization Strategies
If you choose a lump sum, you will know the present value of that money. But how will you determine the present value of your annuity payments over time? Consider how you invest the lump-sum amount vs. the monthly annuity payments.
Other deciding factors include:
- Your retirement age,
- Your health and longevity,
- Your current financial situation,
- Your risk tolerance,
- Estate planning considerations,
- The projected investment return for a lump-sum investment,
- And inflation protection.
Work with your financial advisor to determine which payout method works best for you and your retirement goals. Your advisor can help you determine what other savings pots you have and how that will cover your estimated expenses in retirement.
If you need help deciding on your pension payout plan and how it fits into your retirement income strategy, please contact us today.
Craig Toberman is a Partner at Toberman Becker Wealth – a fee-only, fiduciary financial advisor based in St. Louis. He assists families and businesses with strategic financial planning and long-term wealth management. He has over a decade of experience in financial services and has crafted custom financial plans for hundreds of families and businesses.