Pension Choices

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Often in financial planning, we face questions where the right answer is based on weighing a choice’s pros and cons and understanding the tradeoffs.

Pension choices are one of those questions.

If you are covered by an employer pension, you will face choices at retirement that can have long-lasting financial impacts. However, because we don’t know how long you are going to live, or how long your spouse is going to live, the mathematical correct answer is unknowable. These choices are often very subjective.

Here are the big ones, along with the factors to consider when trying to decide:

Lump-Sum vs. Pension Payments

Not all pensions allow for lump-sum distribution. Some allow you to take a lump sum, usually as a rollover into an IRA. Then you invest the funds and withdrawal them as needed rather than have a set, monthly lifetime payment.

Lump-Sum PROS: Taking the lump sum can be good if your income needs are low relative to your overall portfolio, allowing you to be certain you can make your investments last. It can also be a good choice if leaving the money to your beneficiaries is more important than your spending needs.

Lifetime Payment PROS: If you are concerned about making your money last, and concerned about longevity, then taking lifetime pension payments may be the better option. A pension also takes the investment responsibility out of your hands and puts it in the hands of professionals.

When to Start Payments

Some pensions allow you flexibility as to when they begin payments, with the payments growing by delaying their start. There are three factors to consider for this question.

1. Longevity: We know that by delaying you’ll get larger payments, and we also know you’ll get fewer payments. The question is how many fewer – and we will never really know until too late.
2. Growth: How much the pension grows by delaying payments. Social Security grows 8% every year you delay up until age 70. However, pensions don’t generally grow by much more than we would expect investments to grow.
3. Investments.  If you delay pension payments after retirement you will most likely need to take funds from somewhere else, so liquidity and expected portfolio return are another factor to weigh.

Single-Life vs. Spousal Coverage

For married pension participants, there is usually a choice of covering just your own life or covering your life as well as your spouse with all or a portion of your pension. If you choose the single life, the payments will be larger, but they will end when you pass away. Covering your spouse means smaller payments, but the payments would continue if you passed away first.

Spending. The first consideration is to look at your overall plan and determine how important the pension income is as a component of overall spending. If both spouses would need the pension income, then spousal coverage probably makes sense.

Expected relative longevity. This is another factor and very tricky to judge. Wives tend to outlive husbands, so if the husband has the pension, then often spousal coverage looks good. Age differences and health are also factors to consider. Life insurance can be used in place of spousal coverage, providing a lump sum to the spouse if the pension holder passes away. However, the cost of life insurance may likely outweigh the difference in pension amounts.

Health benefits. Some companies that offer retiree health benefits tie those benefits to pension choices. If a spouse isn’t covered by a pension, they may lose health benefits if the pension holder passes away. This may not be a common issue but is a consideration. Check the plan for details.

Like so many financial planning questions, you won’t know if you made the mathematically correct choices with your pension until many years after you must make them. The secret is to make informed and logical choices based on your specific scenario and make sure you are comfortable with the range of possible outcomes.

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