Unless you work for the government or are a select union member, there’s a good chance that you do not have a pension waiting on you on that last day of work. Recent studies show that less than 10% of private companies do not offer a pension plan to their employees, and instead offer some type of defined contribution plan...like a 401k. With a 401k type of retirement plan, it’s all about growth until you retire and then you are on your own when it comes to creating a retirement annuity or income annuity that provides payments for the rest of your life.
So if you are fortunate enough to ask the question of which is better, a pension fund or a retirement annuity...you need to be able to make an informed choice. If there is no pension fund or plan you are a part of, then you possibly need to pivot to your own personal retirement annuity.
Regardless of the retirement benefits you already have in place, most retirement plans need to have a specific plan in place for a guaranteed income stream that you can’t outlive.
If your private sector employer has some type of defined benefit plan, at the end of your tenure they might offer the choice of taking a lump sum or a lifetime payment guarantee. If you don’t need income, then my advice would be to take the lump sum and invest that money.
If you do need a lifetime income stream, then you have to make a decision on whether to take the payment guarantee from your employer or use the lump sum to buy a Single Premium Immediate Annuity (SPIA). My advice would be to take the guaranteed dollar amount payout number and find an objective annuity calculator that shops all carriers. Whoever has the highest contractual payout after an “apples to apples” quote comparison is the one you choose.
I have found that over 80% of the time the lifetime income offer from your employer will be higher than the SPIA number from the street. The reason for this is your company wants to hold onto the money and not have to come up with a lump sum. Makes common sense if you think about it.
The only caveat to going with that higher pension number your employer is offering would be their claims paying ability. Even though there is governmental backing through the PBGC (Pension Benefit Guaranty Corporation), you need to feel comfortable with the financials of your company.
Is an annuity the same as a pension? The short answer is yes. Pensions and annuities are pretty much the same contractual structure. Both primarily base the payments on your life expectancy(s) at the time you start the income stream, and both are on the hook to pay regardless of how long you live.
How does pension annuity work? Both offer pension payments or a guaranteed income stream through a monthly payment you can depend on. The pension annuity payments solve for longevity risk, which is the fear of outliving your money.
Should I take a lump sum pension or annuity, and which one is better? There’s no perfect answer to this question. If you don’t need the income, then take the lump sum. If you need the income, then shop the company’s guaranteed income offer to make sure you are going with the highest number available.
Every single working American already owns an income annuity, it’s called Social Security. I know that’s a tough one for the army of “annuity haters” out there, but facts are facts.
So is an annuity a retirement plan? The answer is that it depends on the type of annuity you are considering. Some are designed for lifetime income and some are structured for principal protection, death benefit, or long term care/confinement care.
If you are buying a specific annuity type to provide a guaranteed lifetime income stream, then that annuity can certainly be a part of your overall retirement plan.
With Social Security being the foundation of most people’s “guaranteed income floor,” annuities are the only financial product on the planet that can provide a contractual income stream regardless of how long you live.
By the way, most annuities that solve for lifetime income are classified as a fixed annuity. Annuities are an insurance product issued and backed by life insurance companies. That includes the Variable Annuity (VA) product, which is uniquely classified as a security. VAs offer potential tax deferred growth tied to the stock market, using separate accounts (i.e. mutual funds).
With that little bit of product foundation in place, when you shop for annuities...you should shop like you are on Amazon or if you were on Orbitz shopping for a plane ticket.
Annuity contracts (i.e. annuity products) are commodities, and should be shopped with all carriers using an objective annuity calculator that finds the highest contractual guarantee for your specific situation. Your life expectancy (or life expectancies if “joint”), at the time you want to receive payments, is the primary pricing mechanism for lifetime income guarantees. Interest rates play a secondary pricing role.
Before you place your retirement funds, retirement savings, or lump sum payment from a retirement account into a long term income annuity contract, you need to ask and answer the following 3 questions.
From those 3 specific answers, you can structure the quote to solve for the exact contractual goal and find the highest guaranteed number.
It’s really that simple when considering a retirement annuity for lifetime income guarantees. You either need to transfer that risk...or you don’t.