Pensions, or defined-benefit plans, are much less common these days because a pension is a liability on a company’s books. The focus of an employer-provided pension is to provide a guaranteed income for an employee through retirement. The company takes on the risk that they will be able to pay the benefit to employees, which is why many companies have opted for a defined contribution retirement plan, like a 401(k), where the onus is on the employee to save for their own retirement.
So, it’s not surprising when an investor comes to us for guidance because they’ve been offered an early-retirement package and access to their pension before the traditional retirement age. You would think an income “guaranteed for life” would be easy, but surprisingly pensions do come with some complicated decisions.
Generally, a pension will pay out a percentage of the employee’s salary as a qualified joint and survivor annuity, considering both you and your spouse’s life expectancy. This option provides a monthly benefit until the second spouse dies. If you are single, you may receive a slightly larger monthly benefit as payments will stop once you die. The benefit, of course, is the consistent monthly income that can keep your spending in check. There is also the potential for a spousal benefit, once you are gone. The caveat is that the company’s portfolio may perform poorly, or the company may face financial difficulty that could result in reduced benefits. Pension portfolio investments are considerably more restrictive and err on the conservative side.
If you are taking an early retirement offer, the annuity payments from your pension may bridge the gap between early retirement and when other benefits begin. If you have an IRA or other tax-deferred retirement plan, you may not be able to access your retirement money without penalty until you reach 59 ½. If you’re younger than 62, you may also not have access to your Social Security benefits.
However, pension benefits once started, generally, cannot be stopped. If you were to go back to work, pension payments could result in you having too much income, which, in turn, could affect your future Social Security benefits, Medicare premiums, and how much you owe in income tax.
The other option is that an employee can take a lump-sum distribution, rolling the money into an IRA, and taking withdrawals when needed. The benefit of a lump-sum distribution is that you can likely grow your money faster by investing it in the market. You may also be able to leave an inheritance for children—something you may not be able to do with a pension. The downside is that you take on extra market risk. Additionally, if you roll it all into an IRA, you lock up your money until age 59 ½, so you’ll need another source of income during your early retirement years if you want to avoid early withdrawal penalties. Furthermore, if you take the lump sum, you may lose any health care coverage provided by your former employer. Medicare coverage wouldn’t be available until you are age 65, so you’ll have to consider how the extra cost for health insurance would affect your monthly cash flow.
When it comes to receiving pension benefits, there is no one perfect piece of advice. Your decisions are very dependent on your circumstances, your age, your spending and saving patterns, and your access to other assets and health coverage. Consulting a financial adviser to help look at all the possibilities can help. If you have questions regarding your pension benefits, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Disclosures: The following information is reprinted with permission from Forefield, a division of Broadridge Financial Solutions, Inc. This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.</h5
