Pension Decision Planning Services

How Do I Decide Which Pension Option is Right for Me?

A very common decision for current retirees to make is that of which pension option to choose when preparing for retirement from your company, school, or municipality. You’ll see options such as Single Life Annuity, 50% Joint & Survivor Annuity, or Partial Lump Sum Option (PLOP). All these options can have a dramatic impact on your financial wellness, so it’s important to carefully consider the advantages and disadvantages of each option.

pension income options

What Factors Should be Considered When Choosing a Pension?

When trying to decide which pension option is right for you, the old joke is that this decision would be much easier to make if you’ll just tell us how long you plan to live. Because each option has a longevity component to it, we’re really just doing our best to factor your lifespan and that of your spouse into the financial equation to decide which is best.  

If we take this to another level, this fundamental question lies at the very heart of all retirement planning. It’s the very reason for retirement planning; if you and/or your spouse live a long life, you’d better have prepared for it financially. After all, the very notion that we might run out of money before dying is the concern that drives most of our retirement planning decisions. As such, choosing how much money to allow yourself to spend each month in retirement is the flipside of the life expectancy coin.

When one of the families we serve delivers us their packet of paperwork outlining their pension buyout and lump sum options, we get to work to spreadsheet various scenarios. These scenarios highlight which option might be the best choice, given various life expectancies.

An example of pension income options might look like this:

The employee will receive at retirement:

  • $2,000 monthly for life, with nothing left for the spouse, should the employee die first. This is usually called the ‘Single Life Annuity’ option;
  • $1,700 monthly for life, with 50% of that ($850) continued for the spouse until the end of their life. This is a 50% Joint & Survivor option;
  • $1,400 monthly for life, with none of that passing to the spouse, but a $70,000 lump sum is also available. This is a PLOP, a Partial Lump Sum Option

Do You Need Maximum Retirement Income, or Do You Want Maximum Flexibility or Estate Value?

If a person is going to need as much retirement income as possible to be able to retire at their chosen lifestyle, then it’s very likely that one of the pension income options is the best choice. However, if maximum income each month isn’t the highest priority, more options open up when choosing a pension path. Whether the retiree is married or single can also have a large impact on the decision.

So, If You’re Married, Which Pension Option Do You Choose?

As you can imagine, or maybe you’ve already experienced this, the process of choosing can be very nuanced. Maybe the lump sum (which is almost always rolled into an IRA, tax-free) would create a legacy for your grandchildren, or would make for a nice contribution to some long term care planning. Maybe you need maximum monthly income each month and have great family health history and longevity potential, thus leading toward one of the pension income choices.

How Do Taxes Affect a Pension Option?

In addition to these planning variables, another facet of the pension decision to consider is that of tax efficiency. Since pension income is taxable to the recipient as ordinary taxable income, the pension income will result in not only taxes owed on the pension itself, but could increase the tax rate on all of a person’s retirement income sources. For example, receiving pension income each month is likely to cause a retiree’s Social Security Income to be taxed at a higher rate than it would if there was less total income to be taxed. 

As an example, a person who may not need all the income each month that a pension income would provide may be wise to choose the pension lump sum option. Since the lump sum is rolled over into an IRA tax-free, the lump sum can remain tax deferred until later when income is needed or desired, thus resulting in a lower tax rate for the years until more income is needed. This lump sum in the IRA can either be used for periodic withdrawals when desired, or it can be converted into a consistent but smaller income by using an annuity or an income-focused investment approach. The risk, however, is that by deferring the pension lump sum tax until later may cause even more tax owed when Required Minimum Distributions must begin; it could push the taxpayer into a higher tax bracket. Again, this is yet another nuance to be considered in the pension decision. 

With All of the Pension Choices, What Can We Do to Decide What’s Best?  

Each situation is very unique, but the fundamental question is the same: “How long do we think we’ll live, and how do we wish to set ourselves up financially?” Whether you’re presented with a pension choice or not, the moment you step into a retirement planner’s office, you’re contemplating this very question in your own plan for all of your nest egg.

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Contact us to schedule a discussion about pension decision planning and how it fits into a comprehensive retirement plan.

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Fourth Dimension Financial Group LLC

27121 Oakmead Dr.
Suite B
Perrysburg, Ohio 43551