Retiring with a pension is more complicated than simply claiming your payments.
With a company or government pension plan, your choices can range from many to none. “Every pension plan is a little bit different from the other,” says Christine Russell, a senior manager of retirement and annuities at TD Ameritrade. “When you can get the money out and how is almost completely up to the plan and how it is structured.”
What Is a Pension Fund?
A pension, or defined benefit plan, is a retirement fund in which the company makes contributions during the work life of the employee. Upon retirement, employees receive a guaranteed payment that is typically based on a percentage of their average salary and the number of years with the company.
While pensions remain the norm for state and federal employees, the proportion of Americans in the private sector covered by pensions has dwindled to about 13%, according to Bureau of Labor Statistics data. Companies began moving their workers into 401(k)s in the 1980s as they found traditional pensions too expensive, and new employers largely decided not to set up traditional pension plans.
Federal Government Pensions
Federal government employees often have pensions, but they generally don’t have the option of taking a lump sum. In fact, when it comes to their pensions, they have very little to decide, says Caine Crawford, a retirement advisor based in Denver who specializes in federal employees. “You have the option to take a deferred pension if you (retire) early, prior to 62 or full retirement age,” Crawford says. “Otherwise it’s cut in stone. All you can decide is when to retire.”
Private Sector Pensions
Workers in the private sector generally have more options. Russell says the first thing you should do is talk to your human resources department or the administrator in charge of the plan. Get a summary plan description to see the rules about accessing your money. You need to determine when and how you are eligible for payments and if you have the option to take a lump sum distribution and roll your plan over into an individual retirement account. “In the 401(k) world you always have the option of rolling over into an IRA,” Russell says. “In a pension you may not have the option. You may be only able to get it out as a monthly benefit.”
Most private sector pensions are guaranteed by the Pension Benefit Guaranty Corporation. If your company goes out of business or the plan runs out of money, the PBGC pays out promised benefits up to annual limits. Bryan Bibbo, lead advisor at The JL Smith Group in Avon, Ohio, says you should request a pension plan annual report to check on the financial health of the pension. If the plan is underfunded, check to see if the PBGC covers the amount you expect to receive in retirement.
Monthly Check or Lump Sum Payment
To decide which type of payment is a better option, you need to evaluate your personal situation. “Typically, your options are you can take a lump sum distribution, or you can take payments over your lifetime,” says Rich Ramassini, director of strategy and sales performance at PNC Investments. “You can take your payment over a joint life period (both spouses) or you can take your payment for a defined period of time.”
A lump sum gives you immediate access to a large amount of cash, but you become responsible for making that money last for the rest of your life. “Individuals are overwhelmed with do-it-yourself retirement,” Russell says. “This is one of the few areas where you get guaranteed payments for life.”
The monthly payment option can be especially beneficial to retirees who expect to live a long life, and you don’t have to worry about picking investments and potential losses. “You can request a lump sum, but you have to be careful,” Ramassini says. “The (monthly) distribution is for as long as you live.”
Single Life Benefit or Survivor Benefit Option
If you select the monthly payment, your next choice will be whether you want to receive a single life benefit or a joint and survivor benefit. The first choice will result in a higher monthly payment, but when the recipient dies, the benefit stops. If the pensioner dies a month after the pension begins, the payments will end. The spouse must sign a consent form for the single life benefit option, due to a rule mandated by the Retirement Equity Act of 1984 to ensure that spouses are aware that they receive no benefit if the pensioner dies.
The joint life option will result in a lower monthly payment, but if the pensioner dies, the spouse will still receive a lifetime benefit. “You can, in many plans, buy a richer benefit for your spouse,” Russell says. “You might be able to use some of your pension benefits to give your spouse, instead of 50%, maybe 75% or 100% of what you get. It will be in the summary plan report. You can see if it makes sense to get a richer benefit for your spouse.”
Crawford says federal employees have the option of providing a surviving spouse either 25% or 50% of their pension. Their monthly benefit will be reduced by whichever amount they choose.
Period Certain Option
Some pensions allow participants to take a higher payout and receive the pension for a certain period of time, such as 10, 15 or 20 years. With this option, even if the pensioner dies, the checks will continue for his or her spouse or heirs for the remainder of the period. “Every option has advantages, disadvantages and strings attached,” says Kristian Finfrock, founder and financial advisor with Retirement Income Strategies in Madison, Wisconsin. “Look at the impact of losing a spouse. We usually advise the 100% continuation option if they are married.”
Those with a long life expectancy have the most to gain by setting up monthly payments for life. “If the probability that you are going to live a long life is high, (the annuity) could be the benefit that gives you the most income,” Ramassini says. “If your health is not great and you won’t have a long life span, you may want the lump sum or joint life.”