Though pensions are slowly going the way of the buggy whip for many of Americans, for some they are an important part of their compensation and retirement income. Here is what to consider when trying to analyze your pension choices and how best to maximize a workplace pension.
1. Understand your options
Pension payout options can vary from plan to plan, though most have the same core options, there are variations. Here are the main payout choices for a workplace pension:
- Single Life: Usually the highest payout option, however income stops at the death of the pension owner
- Joint Life: Usually 10-30% less income than the Single Life option, but income lasts for both spouse's lives.
- Period Certain: Can be for Single or Joint, and guarantees payments last at least for a fixed term like 10 or 15 years
- Lump Sum: The pension is taken in a one-time payout, and can be rolled into an IRA tax-free
2. Understand the pros and cons of each pension income choice
Pros and Cons of a Single or Straight Life Pension Option - Like any decision you make in life, there are pros and cons. The biggest pro or advantage of a Single Life payout is it provides the highest income. However, the risk is if the pension owner dies early, the payments immediately stop. This is especially a concern for a husband and wife, and the husband has the pension. The life expectancy of men is on average less than women, so a male pension owner who dies early puts the surviving spouse at an immediate disadvantage. Not only does the surviving spouse lose the pension income, but she may live longer - a lot longer - with a reduced income. For this reason, many married couples don't choose a Single Life payout unless it is for a Term Certain or part of a Pension Maximization Strategy.
Pros and Cons of a Joint Life Pension Option - Like the Single Life Option, the main downside to the Joint Life is the asset is lost for the kids. For example, if a Husband and Wife elect a Joint Life payout but then both pass away, the income stops on the second death and the pension ends. The kids in effect "lose the asset" when the pension income ends, there is nothing to pass on, which is unfortunate and why some pension owners prefer taking a Lump Sum.
Pros and Cons of a Lump Sum - Some pension owners may be eligible for a one time payment, otherwise known as a Lump Sum. The Lump Sum can be rolled into an IRA tax-free and invested. This is the biggest advantage of a Lump Sum, control. You control the asset, meaning you can pick and choose how the money is used and invested. I usually prefer the Lump Sum choice for two reasons: 1. The money in the IRA can be invested for greater growth than the pension 2. The asset is still in the family, meaning the kids can inherit the IRA. The biggest perceived downside to taking a Lump Sum is the loss of guaranteed income. However, income can be recreated in the IRA by purchasing an annuity or by creating a diversified portfolio. This is why I favor a Lump Sum rollover into an IRA, for the greater growth opportunity on the money and the kids don't lose the asset, they can inherit and possibly stretch the IRA distributions over their lives.
3. A Word on Pension Maximization
Pension Max uses the Single Life payout to maximize guaranteed income but in conjunction with Life Insurance to ensure some money is left to the surviving spouse. Essentially, you are taking the difference between the Single Life and Joint Life payout and purchasing Life Insurance. This provides the husband and wife with the highest pension income and the Life Insurance provides money for the surviving spouse or children, replacing "the lost asset" if the pension owner dies early. The numbers don't always work with this strategy, sometimes the one spouse is not insurable or the Life Insurance is costly. Suffice it to say, working with a professional who can help you select the right Life Insurance policy is a good idea.
All in all, pensions can play an important part to retirement security. However, proper planning is warranted, after all the income option you select is usually irrevocable - you can't change it once you start the income - so it's best to plan ahead and ensure you fully understand all of your options. If you are interested in learning more or would like to discuss our Pension Maximizer Planning Tool, where we provide you a pension analysis which shows you how best to take your pension, for a one-time fee, please email me at Michael@Executive-WealthCreation.com