by Amy Shepard, CFP
Although pensions are becoming less common as an employer benefit, those who are fortunate to have one should make sure to thoroughly understand all the options before deciding how to receive their pension payment. This article outlines the most common payout methods and provides some examples of when each option might make sense. The important thing to understand is that, like most financial decisions, this is not a “one size fits all” decision — there are many variables and it’s important to evaluate your individual situation so you can make the best choice for your retirement.
Single Life Payout
This is often the simplest option to understand: it pays income to the retiree for their entire lifetime. If you start a single life pension at 65 and die at 66, that’s it; the payments stop even if you’ve only received one payment. If you start at 65 and live to 100+, you’ll continue to receive payments as long as you’re living.
Pros: The benefit of a single life pension is that it typically has the highest payment compared to other options described below.
Cons: A potential negative aspect of the single life pension is that it stops at the retiree’s death so no income would continue to a surviving spouse or possible beneficiary.
Example: Generally speaking, a single life payout is most appropriate for single retirees who don’t have anyone else relying on their income. Another scenario where a single life option may be appropriate is for a married couple who both have pensions. If they each elect the single-life option and their individual pensions are sufficient to cover their expenses, then they wouldn’t be reliant on the other spouse’s pension for a comfortable retirement.
Single Life Payout with Period Certain
This is similar to the single-life payout in the sense that it pays out for the retiree’s entire life. The difference is that this option has a set length of time it will provide payments, even if the retiree dies. For example, a single life with 10-year period certain means the payments will continue for the retiree’s lifetime AND for a minimum of 10 years. So, if the pension starts at age 65 but the employee dies at 66, the remaining 9 years of payments will go to a named beneficiary. If the pension starts at age 65 but the employee dies at 70, payments will stop since the 10-year period has already passed.
Pros: Guarantees lifetime income and also guarantees a minimum benefit over a period of time. Provides an opportunity to leave something to a beneficiary in the event of an early death.
Cons: Provides slightly less income than a straight-forward single life payout.
Example: One instance where this could make sense is for a single retiree who plans to gift to family during retirement. If this option was selected, the retiree could plan to gift a portion of the pension each year while living but also guarantee that if he or she died early, at least a set number of years would get paid out to his family.
Joint and Survivor Payout
This option pays out benefits for a combined lifetime of a married couple. If the retiree were to pass away first, benefits would continue to be paid to the spouse for as long as they live. There are several types of joint and survivor payouts:
- 100% joint and survivor: This means that the full benefit is paid to the retiree will continue to the spouse at the retiree’s death. For example, if the retiree was receiving $1,000/mo, the surviving spouse would continue to receive $1,000 for the rest of their life.
- 50% joint and survivor: If the retiree dies first, the surviving spouse would receive half of what the retiree was receiving. For example, if the retiree was receiving $1,000 per month and died, the surviving spouse would receive $500 per month for the rest of their life.
- Other options: There are many other combinations of joint and survivor payouts available. They all work the same way just with varying benefits continuing to the surviving spouse.
Pros: This option guarantees income will continue for two lifetimes rather than just one.
Cons: The higher survivor payout elected, the lower the benefit will be.
Example: For a married couple with little or no Social Security benefits, the 100% joint and survivor benefit could make sense because it guarantees a set amount of income for each of their lifetimes, regardless of who dies first. For a married couple with sufficient investments outside of Social Security and pensions, an option like 50% joint and survivor could make sense because the survivor would not be reliant on the full pension to cover their expenses.
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Over/Under or Social Security Offset
Some pensions offer the previous payout options but also add an option called “over/under” or “Social Security Offset” where you receive a higher payment before age 62 and then a lower payment at 62 and beyond. This is intended to help you keep your income level in retirement; you’d receive higher pension income until 62. Then, if you started Social Security benefits right at 62 and combined that with the now-lower pension, you’d essentially have the same amount of money coming in, it would just be from two sources instead of one.
Pros: Gives you more money in the earlier years of retirement.
Cons: For many retirees, starting Social Security at age 62 is not the optimal strategy, so this approach could cause you to receive fewer Social Security benefits over your lifetime. Another consideration is your life expectancy; if you are healthy and expect to live a long life, this approach could cause you to receive fewer pension benefits over your life because you get higher pension benefits for the first few years but lower pension benefits for the rest of your life.
Example: This approach could make sense for someone who has a shorter life expectancy and needs or wants to retire “early” (in their 50s or early 60s). If someone retired at 55 and had a life expectancy of 15 years, this option would give them a higher pension income from 55-61. Then, the pension would decrease at 62 but Social Security would start, ideally making up the difference.
Lump-sum Payout
This option provides a one-time payment instead of a lifetime income. For example, the options may be a single life payout at $1,000/mo for your lifetime OR a one-time lump sum payment of $200,000.
Pros: A lump-sum payout provides more flexibility; you have immediate access to a large pot of money that can be used however you want. This option also has the potential to leave more assets to heirs since there is no dependency on your life for payments to continue.
Cons: Taking the lump-sum means giving up guaranteed lifetime income. In retirement, having a guaranteed lifetime income can be a very important part of a retirement plan. If you took the lump sum and spent it down quickly, that could have a negative impact on the long-term success of your retirement plan. If you took the lump sum and invested it in a way that didn’t match your retirement goals, it could be down in value when you need it which could also have a negative impact on the long-term success of your retirement plan.
Examples: It is rare for me to recommend a lump sum payout, but it does make sense on occasion. One example is when a retiree has multiple pensions, say 3; if two of the pensions plus Social Security are enough to cover all expected expenses, the third pension could be paid out as a lump sum. Another example is a partial lump sum, where a portion of the pension is paid out in cash but the remaining value is payout over the retiree’s lifetime.
As you can see, there are many options for how a retiree can receive their pension benefit. The best way to evaluate these options is by doing a comprehensive retirement plan where you look at the big picture and consider how all the variables work together.
About the author: Amy Shepard, CFP®, RMA®, BFA™, MBA
Amy Shepard, CFP®, RMA®, BFA™, MBA is a partner and financial planner at Sensible Money. She has been working with clients since 2013 and loves helping them create and implement a financial plan so they can achieve their life goals. She is involved in the CFP Board’s Mentor Program and previously served on the board of the FPA of Greater Phoenix. Outside of work she enjoys spending time with her husband and kids – they have a goal to take a family picture in all 50 states!
