Don’t Goof Up These 3 Big Pension Decisions
You could outlive your money if you choose the wrong time and way to take your pension
If you’re lucky enough to have a pension waiting for you when you retire, congratulations. If you’re really lucky — and if you make some smart decisions about how and when to receive your pension — it will last as long as you live. If you make poor choices, however, you could outlive your benefits, impoverish your spouse and settle for much less than you earned.
Here are the three important decisions you’ll face, with advice on how to choose what’s best for you.
Annuity or lump sum?
If you take your pension as an annuity, you’ll get a monthly check until you die. Most private employers don’t adjust pensions for inflation, however, so your monthly check will lose purchasing power over the years.
There’s also a risk that your old employer may go bankrupt and renege on its pension promises. If your employer terminates its pension plan, the federal Pension Benefit Guaranty Corporation may guarantee you’ll receive the benefits you’ve earned, but only up to certain limits. Go to the PBGC’s website to find out if it insures your plan and to check current maximum monthly guarantee limits.
If you take your pension benefits in a lump sum, you can invest them for growth so your retirement income keeps up with inflation. If you roll a lump sum over into an Individual Retirement Account, you won’t have to pay taxes on the money until you begin withdrawals.
Moreover, you’ll have a cash reserve that you can tap in an emergency. After you die, your heirs can inherit what’s left of your lump sum.
Of course, if your investments perform poorly or you spend too much of your lump sum on new cars or cruises, you may run out of money before you expire.
You could hire an accountant or financial planner to project whether an annuity or a lump sum will pay you more over your lifetime. But it’s impossible to predict because you don’t know how long you’ll live or how much your investments will earn. As a result, it makes more sense to figure out what role your pension should play in your financial life, given your other assets.
Start by estimating your post-retirement expenses. Also get an estimate of the Social Security benefits you’ll collect. If Social Security benefits, which increase with inflation, will cover all or most of your recurring bills, you may not need or want another annuity. If you need more cash to keep the electricity on, however, take your pension as an annuity to boost your guaranteed monthly income.
Single-life annuity or another type?
If you choose to receive your pension as an annuity, you’ll probably be able to choose between three settlement options: single-life, joint-and-survivor and life with period-certain.
Single life: A single-life annuity will give you the most money each month, but the checks will stop when you die. This option makes sense if you have no dependents or can provide for them some other way after you’re gone.
Joint-and-survivor: Under federal law, if you're married you must choose a joint-and-survivor annuity unless your spouse signs away his or her right to it. This type of annuity pays until both you and your spouse or other named beneficiary are dead. The amount you’ll collect is based on your survivor’s age as well as your own. You can typically choose a joint-and-survivor annuity that pays 100, 75 or 50 percent of your monthly benefit to your beneficiary.
Life with period-certain: This annuity pays you and a beneficiary for at least a specified number of years, typically 5, 10, 15 or 20. You’ll collect less than you would with a single-life annuity but more than you would with a joint-and-survivor pension because a period-certain annuity's payout period is limited. This option might work for you if you’re single and want to ensure that at least some portion of your pension benefits pass to your heirs if you die young.
Collect benefits early or wait?
Under most pension plans, you need to be age 65 to receive the maximum benefit. It pays to wait until then to start collecting unless you’re desperate. You’ll typically lose about a third of your benefit if you take your pension at age 60 and half of it if you start collecting at 55.
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