Winding Through the Maze of Pension Options

Investing
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By Audrey Jones

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It wasn’t too many years ago that company employees would receive a gold watch upon retirement, as well as a pension check each month for the rest of their lives. More recently, retirement options have become more numerous and confusing. Funding pensions has become more burdensome for employers, and administering them has become so much more complex that companies prefer to rid themselves of that responsibility entirely. As a result, we’re seeing what may be the most confusing pension option yet: the lump-sum distribution. That’s not to say the lump-sum option isn’t worth considering; far from it, but understand that it is the company’s way of transferring responsibility to you. More on this later.

The traditional pension provides payments for the rest of an employee’s life after retirement. The responsibility for that payment lies with the retiree’s former employer. Retirees want assurance that the payments will continue for life — but with many pensions being insufficiently funded, that’s not necessarily guaranteed. So you may want more control.

Straight life vs. joint and survivor

If you prefer traditional payments, you have choices to make. A married person must decide whether to take the “straight life” option or the “joint and survivor” option. With straight life, you get payments until you die, but your spouse gets no benefits after your death. In the joint and survivor option, you get smaller payments than with straight life, but your spouse continues to receive payments after you die. An actuary calculates how much should be withheld from the “original” pension to fund your spouse’s allowance after your death. This can be accomplished in different ways — and in many cases to your advantage.

The next consideration involves whether a retiree can get life insurance. If not, then it is best to stay with the company’s payment options or possibly take a lump sum payment. If you are insurable, you may have another option. This involves a two-step process:

  • First, figure out how much money your spouse will need after you die — in other words, what your spouse’s “survivor’s pension” needs to be.
  • Next, find out what the premium would be for a life insurance policy to fund that survivor’s pension after your death.

If the cost of the premium is less than the difference between the joint and survivor and straight life traditional options, then get the insurance and take the straight life option. You’ll get higher payments while you’re alive, and your spouse will still get payments after you die.

In such a situation, if your spouse died first, the insurance policy could simply be canceled. Many traditional pensions do not allow changes once payments begin, so you could be left with a lower monthly payment for life if you had taken joint and survivor. (Note: It’s critical that you have an issued life insurance policy in hand before choosing this option.)

Looking into lump sum

Now it’s time to determine whether a lump sum distribution may be best. Ask yourself these questions:

  1. Do you want to provide for children after you die? Most traditional pensions are only for retired employees and their spouses. If you have a “life and 10 years” option, income will go to heirs only if you die within the 10 years of retiring, and those payments will stop at 10 years after the date you retired.
  2. Will your health prohibit you from living to average life expectancy? The calculations for pensions are based upon the average life expectancy. You may not receive the full benefit of your pension if you are not in average health.
  3. Do you have sufficient income from other sources to fund your retirement? If you have income from other sources, you may not need guaranteed pension payments.

If the answer to any of these questions is yes, then a lump-sum distribution may be best.

Where do you start?

Ask for help. Seek advice from a certified financial planner who can begin to review and organize your estate and finances at least six months before you retire. What you don’t know about your options can hurt you.

Schedule a meeting with a qualified fee-only financial planner. Take time to ask questions. Clarify your priorities and personal preferences and discuss specifically what you would like to accomplish as you move toward retirement. Be sure that your planner understands your needs, not just your assets. Your financial planner can create a customized, long term financial vision based on your specific circumstances and wishes. Ask the planner about a “discovery” meeting to help you uncover your financial desires and profile/personality. Most will provide this initial consultation at no charge. You can go to napfa.org to search for fee-only planners in your area.