How Do You Get the Most Out of a Pension or Annuity?
Pensions and annuities can be a way of securing a consistent and predictable income during retirement. There are any number of ways to structure them, but one of the key points to think about when setting up a pension or an annuity is how your loved ones will be protected if anything should happen to you.
“People are living longer and longer, which is a great thing,” says Northwestern Mutual Wealth Management Advisor Greg Telge. “But they are afraid of running out of money if they live longer than they had planned for, and they are also still very concerned with securing a legacy for their family and loved ones.”
Making the Most of a Pension
You will likely have options when choosing how you structure your pension when you take it. Here are some key considerations:
- Inflation: Will your pension adjust for inflation, or is it a flat-rate payment? Knowing this can help you better prepare a full retirement strategy.
- Beneficiaries: A beneficiary is the person or entity that will receive payments or a lump-sum payment in the event that you die. If you have children or other dependents you want to name as the beneficiaries, you will have to check whether or not your pension plan will allow you to do so.
- Allocations: How you choose to collect your pension funds can affect whether or not beneficiaries will still be able to get money from your pension when you pass away. Here are some of the options that you may want to consider:
- Lump sum vs. payments over time: Most pensions will allow you to choose between taking a one-time lump-sum payment or taking payments over time. If you choose a one-time payment, the amount of money may be less than a lifetime of payments for you and your spouse, but you could use that money as you want and pass it along to your loved ones in any way you like.
- Single Life vs. Joint Survivor: If you choose to turn your pension into a monthly payment, you will have to decide if you want a single-life plan or a joint-survivor plan. A single-life plan pays benefits to you only while you are alive. A joint-survivor plan would continue to make payments to a second person, such as your spouse or a loved one, after your death. A single-life plan will pay out at a higher rate, while a joint-survivor plan will pay out at a slightly lesser rate because it is assumed the funds will need to be paid out over a longer period of time.
In recent years, many workers have found their pensions restructured or cut back by their employer. Telge says it’s important to look at the financial health of your company when thinking about how your pension may fit into your retirement plans. “You want to try to determine just how much you can or should rely on this pension being your mainstay in retirement,” cautions Telge. “If you and your spouse are going to rely on this income, you should look at the stability of the pension plan.”
What Are My Options If I Don’t Have a Pension?
Annuities are insurance products designed to create income in retirement.1 They come in many variations. Some are immediate and begin making payments as soon as you buy them, while others are deferred and make payments beginning on a specified date or when you reach a certain age. There are a variety of different types of annuities. You can buy everything from the most conservative annuity with which the income payout is guaranteed2 to variable annuities that are tied to investment returns.
Telge says determining which to buy requires analysis and research. “When people begin looking at how to structure their retirement, first we run a cash flow analysis of their situation both into and through retirement,” he explains. “We take a realistic look at life expectancy in today’s terms, we factor in inflation, and we talk about their tolerance for risk. Once we determine how much monthly income they think they and their family will need, we set a plan in place that meets those needs.”
As with pensions, Telge emphasizes, it is vital to take a close look at the company selling the annuity. “You need to look at the history of the company and its financial strength,” he says. “You also want to ask about all of the costs and fees associated with the annuity—everything from penalties if you try to withdraw funds too soon to maintenance and allocation fees. Get all of the costs up front.”
Just like the options you have for pensions, annuities have flexibility in how you create income and for how long it lasts. Here are some options you will want to consider:
Determine Structure and Payouts
- Period certain: You set a specific period of time for a guaranteed payout, for instance 10 or 20 years. If you pass away before the end of the period certain, whomever you’ve named as your beneficiary will continue to receive the payments until the period is over.
- Lifetime payments: Guarantees regular payments to you for as long as you live.
- Income for life with a period certain: Combines both of the above; if you pass away during the period certain, whomever you’ve named as your beneficiary will continue to receive the payments until the period is over. If you live longer than the period certain, you will continue to receive payments until you die.
- Joint and Survivor: A lifetime payout over the lives of you and a loved one. The payments will continue until both of you have passed away.
“Many people have misconceptions about annuities and believe they are taking money from their children’s inheritance,” says Telge. “But annuities are so flexible, and there are ways to pass the funds from an annuity to your heirs in the event of an early, unexpected death. They can also provide financial security in later years, which can ultimately lessen the financial burden on their children.”
1Withdrawals from annuities may be subject to ordinary income tax, a 10% IRA early withdrawal penalty if taken before age 59 ½ and contractual withdrawal charges.
2All annuity guarantees are backed solely by the claims-paying ability of the issuing company.