If you are lucky enough to have a pension through your employer, you are sitting on one of the most valuable retirement benefits that still exists. But here is the thing: the decisions you make in the years and months leading up to retirement can have a permanent impact on how much income you receive for the rest of your life. Get it right and you are set. Get it wrong and there is no going back. Let us walk through the key pension decisions worth understanding now, whether retirement is five years away or fifteen.
Why Pension Decisions Are So High Stakes
Unlike a 401(k) where you control your investments and can adjust over time, a pension typically locks in your payout based on a few key factors: your years of service, your final salary or average salary, and the payout option you choose at retirement. That last one, the payout option, is where most people make their most consequential decision. And unlike almost every other financial choice, this one is usually irreversible.
The Key Pension Payout Options
Single life annuity. This option pays you the highest monthly amount, but payments stop when you die. If you have a spouse or dependents who rely on your income, this option leaves them with nothing after you are gone.
Joint and survivor annuity. This option pays you a lower monthly amount, but continues paying a percentage of your benefit to your spouse or beneficiary after you die. The percentage varies, typically 50%, 75%, or 100% of your benefit. The higher the survivor benefit, the lower your monthly payment.
Lump sum option. Some pensions offer the ability to take your entire benefit as a single lump sum instead of monthly payments. This gives you flexibility and control, but it also puts the responsibility of managing that money entirely on you. If you invest it well, you could come out ahead. If you do not, you could run out of money.
Factors to Consider When Choosing
Your health and life expectancy matter here. If you are in excellent health and have a family history of longevity, a lifetime annuity may be worth more to you over time than a lump sum. Your spouse's financial situation matters too. If your spouse has their own pension or significant retirement savings, you may have more flexibility to choose the single life option. If they depend on your income, the joint and survivor option provides important protection. Your other sources of retirement income also factor into how much risk you can afford to take with your pension decision.
Do Not Wait Until the Last Minute
Pension decisions are not something you should figure out in the final weeks before retirement. The best time to start understanding your options is now, while you still have time to plan around them. Request a pension estimate from your HR department or pension administrator. Review your options carefully. Talk to a financial professional who can model out the different scenarios based on your specific situation. Your pension is a powerful asset. Make sure you are making the most of it.