Pension or Annuity?

This question puts a lot of people on the hunt for annuity information.  Most of what you’ll find is just standard portfolio management information or an annuity sales pitch, so like everything else I’m going to try and cover all the angles.  Some people don’t have pensions at all while others have to decide between taking pension payments or a lump sum from an employer.

For those who don’t have a pension at all, the question can be answered by using a more general approach to retirement planning.  Do you need additional income to cover expenses?  If yes, then an annuity is probably a really good idea.  If not, then there are several other ways to stabilize your portfolio with an annuity.  But it doesn’t relate to the pension question so give me a call if you want to take a deeper look at it.

For purposes of this newsletter and podcast I’m going to address the question of whether to take the income payments or the lump sum from an employer pension.  For every person the answer is different and it comes down to both what you need and want.  There are some who need the income while others don’t and would rather not see an increase in taxable income during retirement.  I’ve met a lot of people that fall into one of three categories so let me explain each.  If you are faced with this decision then it’s likely that one of these fits you.

I Need The Income:

Those seeking income have a pretty easy calculation to determine whether they get more from the pension payments or more by moving the money out to a private investment.  Using an annuity is the closest similarity but any mix of investments can do the job, depending on how much risk you want to take.  Start with figuring out what the income payments as a percentage of the total lump sum.  

There are several options for income payments with an employer pension.  Single life, joint life, term period certain and various survivor options on joint life payments.  Pick the one that suits your situation first.  If you figure out it’s 5% of the total amount then you have a benchmark to shop for alternatives.  There’s a lot of resources available publicly if you know what to search for, or you can just call someone like me and I’ll help you figure it out.

If you really need the income then it’s senseless to use anything but an annuity as an alternative.  There’s even an argument for an annuity being much safer than a corporate pension and in many cases I agree.  So even if you can match the income with a private annuity then it’s probably a good idea to switch.  Obviously if you can exceed the pension income with an annuity then you would be crazy not to do it.

For what it’s worth, I’ve met several people over the years who have taken less income with a private annuity because the employer pension had a clause allowing the company to lower payments if the pension fund was in trouble.  They got more security and a better guarantee by going with an annuity.  This isn’t the case with every pension so you need to look into the plan documents of your pension before you let it worry you.

The biggest issue with this option is that you can leave no remainder to heirs with an employer pension, at least none that I’ve seen.  If you don’t live long enough then you won’t get all the money out of it

I Don’t Need The Income:

This is the most broad category of the three and it’s not just because the people who qualify don’t need the money.  Maybe it’s just that income is not the most pressing issue for this group.  Sure, plenty of people can rely entirely on social security alone and more income would only increase a tax burden.  For others, the pension lump sum might be a relatively small percentage of total assets. In either case it makes sense to manage the assets from a pension separately for other retirement needs.

It’s all about control.  Who do you want to be in charge of your retirement assets?  The list of reasons you might take this path are personal and the number of things you can do with the money is long.  Some would choose to put this in a managed portfolio of stocks and bonds but an annuity works just as well for anyone who wants less risk.  It’s a personal decision and an annuity should be part of the discussion.

This reminds me of when Primerica, a national brokerage firm, came under fire for recommending federal employees take the lump sum instead of pension payments.  I watched the congressional hearings and it was maddening to hear the Primerica CEO stumble over the answers to his questions.  I tell this story in more detail in the podcast but it was frustrating to listen to it.  All he had to say is that some people don’t need the income and would rather have control over the asset.  I’m pretty sure he didn’t know what to say because of the types of investments used to replace the pension.

I Don’t Need All The Income:

This is a combination of the above two for people who are similar to those who can live on social security and other investments like rental income or dividends. If a portion of your pension payments provide a comfortable living you should probably take the lump sum.  Use a portion of the money to secure the income you need and open up some more possibilities with what’s left.  It’s possible that some employer pensions will allow you to split a portion of income with a portion of the lump sum but I’ve never heard of it.  In all likelihood you would need to roll the pension into an IRA before sending it to your financial vehicle(s) of choice.

As you can see the question has no single answer for every person.  What you do and how you do it will depend on what you want and need as well as your desired level of independence.  You have to be able to run some numbers and make a good objective decision.  As with everything else, you only get to do it once.  I’ve done it hundreds of times, with no emotional connection to your numbers.  If you want an objective analysis of your options then make an appointment or give me a call.


Written By

Bryan Anderson

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