When it’s time to retire and your employer gives you the option of a lump sum payout or a pension annuity, it can be a tough decision. Which option is better for you and your family? How do you make sure you’re protected for the long term?
There’s no one-size-fits-all answer, despite what some salespeople may suggest. The right choice depends entirely on your personal needs, financial goals, and the specific terms available to you. Let’s break it down to help you understand the pros and cons of each option.
Two Key Questions to Ask Before You Decide
Before diving into the numbers, it’s important to first ask yourself:
- What do I want my money to do for me, and what guarantees do I need?
- When do I want these guarantees to start?
These questions are essential because they will shape your decision. For example, if you don’t need income right away, you might choose to roll your lump sum into an IRA, or perhaps invest it in a principal-protection annuity like a Multi-Year Guaranteed Annuity (MYGA) or a Fixed Index Annuity.
On the other hand, if you need consistent income immediately or you want guaranteed lifetime income for you and your spouse, then a pension annuity, also known as a Single Premium Immediate Annuity (SPIA), may be the right choice.
Understanding Your Company Pension
If your employer offers you a pension option, they are essentially offering a SPIA, which is a type of annuity. This contract promises to pay you a set amount of money every month, starting within 30 days to a year, depending on how you structure the plan.
To make an informed comparison, here’s what you need to do:
- Request an exact monthly payout figure from your employer.
- Get an outside quote for a SPIA under the same conditions to compare.
This will allow you to see if the offer from your employer is competitive with what you can get on the open market.
The Reality of Employer Offers
In my experience, about 85% of the time, the pension offer from the employer is better than what I can find with outside providers. Why is this the case?
Employers want to keep your money. They know what the market offers and sometimes adjust their pension offers just enough to make them appear more appealing than external options.
However, that’s not always the case. There are times when the open market can beat your company’s pension offer, which may make rolling your lump sum into an outside SPIA a smarter move.
How to Structure Your Pension Payment
Another important aspect is how you decide to structure your pension. Companies don’t always offer the full range of options you could get from external providers.
Here are some common choices to consider:
- Single Life Only: Offers the highest monthly payout but stops when you pass away.
- Joint Life: Ensures payments continue for both you and your spouse.
- Cash Refund or Installment Refund: Guarantees that unused funds are paid to beneficiaries.
- Period Certain: Guarantees income for a fixed number of years, even if you pass away before the term ends.
For married couples or long-term partners, the joint life option is usually the best choice. It ensures that the survivor continues to receive an income after one spouse’s death, providing financial stability and peace of mind.
The Stability of Your Pension
One of the key factors in this decision is whether the institution behind the pension can actually support their promises. Even if your employer’s offer looks good on paper, you need to be sure that they are financially stable enough to keep paying you for the rest of your life.
If you go with an outside annuity provider, the risk of stability shifts to the insurer, so it’s crucial to select a company that’s strong financially. Regardless of the choice, ensuring the institution is reliable is a must.
No Turning Back
Once you make your choice—whether it’s a lump sum or a pension annuity—you can’t undo it. This is one of the most important financial decisions of your life, so it’s vital to take your time, weigh all the options, and make your decision based on solid facts, not sales pitches or intuition.
The Bottom Line: Focus on Monthly Income
Ultimately, your retirement plan revolves around your monthly payment. Consider these key income sources:
- Your Social Security benefit
- Your pension income
- Your annuity payment
These together make up your income floor, the guaranteed amount of money that you’ll have each month, no matter what happens in the market. This is the foundation of your retirement security.
Taking the time to understand your options, comparing offers, and choosing the right structure for your needs will give you peace of mind and ensure that you’re financially secure in retirement.
