If you are one of the lucky few with a defined-benefit pension, then you might have wondered about what your options are with a pension versus an annuity. But while pensions were a common thing of the past, they aren’t around as much anymore.
In the days before smartphones and social media, many people had only one employer. Throughout their career, folks worked for one company and received a pension when they retired. From there, they would receive payments for the rest of their lives.
Today, unless you have a government job of some sort, pension benefits are rare. An annuity may be a good option for you if you don’t have a pension but like the idea of receiving income for the rest of your life.
As you consider the pros and cons of annuities vs. pensions for retirement, here are some key factors to consider.
How Do Pensions And Annuities Differ?
Both annuities and pensions annuities provide guaranteed income, but they work a bit differently. In some cases, people opt for pensions because they have good retirement savings and simply want a steady supplemental income during retirement. Others, however, may prefer annuities for their flexibility compared to pensions.
Whatever retirement option you choose, the key to a successful retirement is having lifelong income available to you whenever you need it.
What Is an Annuity?
Annuities are insurance contracts that provide guaranteed income during retirement. As you approach retirement and need a strategy to make sure you don’t outlive your income, you may consider an annuity.
A variety of annuity products are available, allowing you to choose the one that fits your needs and risk comfort level. A fixed annuity, for example, specifies the payment amounts that you will receive beforehand. On the other hand, a fixed index annuity can also provide lifetime payments for your income while also giving some flexibility, such as through an income rider.
If your risk tolerance is high, you can get a variable annuity, which can provide higher (or lower) payments depending on the performance of your subaccounts in the annuity.
If you are considering any annuity products for guaranteed lifetime payments, be sure to compare the actual payouts from each product against each other. A direct apples-to-apples comparison will help you judge whether you will get a good deal for your money.
What Is a Pension?
A pension plan is a retirement plan set up and maintained by an employer. You can start receiving pension payments when you retire. Several factors determine the amount of your pension, including your age, salary, and number of years you worked for your employer.
Although pensions have declined in overall popularity, they remain a common benefit for government workers. However, the private sector offers fewer pensions because many private employers have gone to defined-contribution plans such as 401(k)s. They don’t want to manage the more costly liability of pension obligations to workers.
The majority of pensions are funded with pre-tax income. Essentially, this lowers your taxable income while working, but it means you will pay income tax on the backend with pension withdrawals, generally speaking.
Key Differences Between an Annuity vs. Pension
Life insurance companies stand behind the annuity contracts that they issue. As stated earlier, employers provide pensions as a benefit for their employees. They differ by product type and availability in that way.
In an annuity, the retirement saver controls the amount of their annuity premium and how much of their overall retirement savings they commit to the contract. On the other hand, the employer has control of the pension plan, in which it generally makes the contributions and handles payouts (and your pension depends in large part on your job earnings).
To that end, the amount of income from a pension depends on how much someone has earned over their time with their employer. Income from an annuity, on the other hand, is based on the amount put into an annuity contract. Your portfolio can be more diversified in that regard.
With an annuity, you can exchange a portion or all of your retirement savings for a steady, lifelong income. Income from an annuity is protected against investment risks. They can have different features that help your income keep pace with inflation.
On the other hand, with a pension, you will also have a guaranteed income source. There might a question of ‘income continuity,’ or what happens to your pension payments once you pass away, however.
Depending on the payout option you choose, your pension payouts may end upon death. Your loved ones may not receive ongoing payouts if so, even if there is money left over in the pension.
Again, this will depend on the payout option that you choose. That being said, with an annuity, your loved ones may also not have income payments continue to them if you opt for a “life-only” payout.
Should you want your spouse to receive continuing annuity payments, you generally have options there. If continuing payments to loved ones, in general, is important to you, ask your financial professional about your choices.
One of the biggest advantages of annuities over pensions is that you are the one who starts an annuity. The premium amount that you put into the product and the contract you sign are entirely up to you. You can choose the type of annuity that you own and, by extension, have that flexibility in how you will receive payments from a specific annuity.
By contrast, a pension plan is opened by an employer and not an employee. Pension plans have insurance from the Pension Benefits Guaranty Corporation, but if the employer handling your pension goes bankrupt, this agency will step in.
You aren’t guaranteed to receive the full value of your pension in that situation. So, you should be comfortable with the financial condition of your employer, as a pension plan depends on its ability to manage that obligation.
Payout: Lump-Sum vs. Monthly
Both options offer retirement income, but annuities can be tapped before point-of-retirement, unlike what you might find with some pensions. Keep in mind that withdrawals from an annuity before age 59.5 are generally subject to a 10% early withdrawal penalty on top of taxes due.
In addition, you can take money from an annuity in regular payments or as a lump-sum distribution. However, an annuity lump sum will likely be taxable as ordinary income if you go this route.
A pension can be cashed out in two ways:
- Receive payments monthly. As you plan your retirement budget, this is a regular source of retirement income you can rely on.
- You can also receive a pension as a lump sum. This allows you to immediately access all of your money and manage it as you wish (keep in mind IRS tax rules and the potential tax burden if the rules aren’t met).
Can You Roll Over Your Pension?
In short, usually so.
The 1980s saw 60% of private-sector companies offer their employees traditional pension plans, which were typically defined benefit plans. Nowadays, only 4% of private companies offer defined benefit plans.
With private-sector companies discontinuing their traditional pension plans, workers have been encouraged to roll their pensions over into 401(k)s and IRAs.
Two conditions must be met for you to roll over your pension to an IRA:
First, you must be in a “qualified employee plan” that complies with IRS rules.
Second, your pension plan must be closing, or you must be leaving the company, either through retirement or other circumstances.
A qualified pension plan can be rolled over to any retirement account, according to the IRS. If you want to initiate a transfer of funds, it’s recommended that you contact your plan administrator first.
Annuities vs. Pensions: Which You Should Choose?
At the heart of things, are annuities and pensions basically the same? Yes, in a few respects.
They have a similar contractual setup. Payments from both sources are based in large part on your life expectancy – or on your life expectancies, if payouts will be for you and a spouse. Both annuities and pension also are under contractual obligation to pay you income for life.
Many people are attracted to annuities due to their flexibility and the range of choices it can free up for their other retirement assets. For those who have a pension from work, many are satisfied with the easy management of their pension plan for retirement. It’s really an individual question.
Planning for Your Retirement Income Peace of Mind
Whether you have a pension or not, you will want an income stream that you can count on for your monthly lifestyle expenses. Social Security might not cut it by itself.
No two people’s situations are ever the same, so you may want to speak with an independent financial professional in order to fully explore all of your options. You should be able to make confident, well-informed choices, and that starts with a thorough understanding of all options and strategies available to you.
An experienced financial professional can help you explore all of the possibilities. It’s best to make some of these decisions before you stop working, rather than waiting until you are no longer working.
If you are looking for someone to guide you, many independent financial professionals can help you here at SafeMoney.com. Use our “Find a Financial Professional” section to connect with someone and request an initial appointment to discuss your situation at no obligation. Should you need a personal referral, call us at 877.476.9723.