Summary: Choosing the right pension payout option is crucial for couples, as it impacts retirement income and is irrevocable. Options include lump-sum or various annuity payouts. Your decision should be based on financial needs, health, and spouse’s support.
Main Points:
- Pension payout options are critical and irreversible.
- Lump-sum offers flexibility but carries investment risks.
- Annuity payouts provide stable income with different joint options.
- Factors to consider: age, health, other income sources.
- Consult a financial advisor for guidance on retirement security.
If you are vested in a defined benefit pension plan, you have a critical choice to make. Specifically, you need to determine how you’ll receive your pension payout. If you have a spouse, learning which pension payout option is best for couples is vital.
The choice is crucial for two reasons. First, your pension payout is a cornerstone of your retirement income plan. Second, once you choose an option, it is irrevocable.
The choice of pension payout options is never clear-cut, and it can have far-reaching consequences for you and your family. That’s the reason why your choice needs to be based on your financial plan. Your decision should consider several key factors, such as your and your spouse’s age, health, income needs, and income sources.
Looking at Your Pension Plan Payout Options
Most pension plans offer two options – a lump-sum payout and a monthly payout. The monthly payout is an annuity option that can be paid on a single life, a 50 percent payout for joint and survivor, 100 percent joint and survivor (there could be several variations of the joint and survivor options), and life with 10 years certain.
Couples need to take their spouses into account when they make this decision. These retirement benefits are generally counted on for long-term support for both partners after exiting the workforce. Here’s a closer look at each pension payout option.
Lump-Sum Option
The lump-sum payout option results in a one-time payment, as Investopedia explains. The payment is calculated as a present value of the stream of payments you would have received with a monthly payout. Generally, the formula applies a discount rate tied to the 30-year Treasury note.
You can invest your lump sum payment in any way you choose. However, unless you roll it into an IRA, the entire amount will be counted as ordinary income in the year it’s received and taxed accordingly.
If you roll your lump-sum pension payment into an IRA, the taxes are deferred until you withdraw the funds from your IRA. If you withdraw any funds before the age of 59 ½, they will be subject to taxes and a 10 percent penalty.
When to choose a Lump-Sum option
There are several reasons why you might choose a lump-sum payment option. While it doesn’t provide the guarantee of long-term income, it can even be the best pension payout option for couples in certain circumstances.
Here are a few scenarios where a lump sum may be the best option for pension payout for both individuals and couples:
- If, for health reasons, you don’t expect to live to your life expectancy, a lump sum can make sense. You might consider managing your own investments, or working with fiduciary financial advisors to help you do so, rather than taking a fixed income over a shortened lifespan.
- If you’re not married, a lump-sum payment would also provide you with more flexibility in determining how to pass the remainder to a family member or charity.
- If you’re confident you could out-earn the monthly payout by investing the money on your own. This can apply to both individuals and couples.
- If you, or you and your spouse, don’t need the monthly income and would rather control the pace of withdrawals yourself.
- If you don’t want to rely on the financial stability of the company’s pension plan. Companies may not be able to properly fund their pension plans for your entire life so that is a risk to consider if you do not take the lump sum option.
All are perfectly valid reasons for taking a lump-sum payment instead of monthly payments. However, remember that you bear the risk that your investments may underperform. Choosing the right investment advisor then becomes the next critical decision.
Annuity Payout Options
Annuity payout options can provide a more consistent and reliable stream of income for couples. However, there are several options under the annuity umbrella to consider. And, as outlined above, a lump-sum pension payout option can make more sense in certain situations.
To begin making this choice, it’s important to understand how your pension payout is calculated. Your monthly pension benefit is calculated based on your earnings and years of service.
For example, your benefit amount might be equal to two percent of the average earnings you received over your last five years of service, multiplied by your total years of service. However, your actual monthly payout amount will be dictated by the annuity option you choose.
Single Life Annuity
The single life annuity option guarantees a fixed monthly payout for Life. Since the payout is based on a single life, it generates the largest monthly payout. Once you die, the pension goes away.
When to choose the Single-Life Annuity optio
This choice is relatively clear-cut if you are single with no dependents. There’s simply no need to consider the joint and survivor options when they aren’t applicable to you.
If you are married, you should probably look at one of the joint and survivor pension payout options. However, if you have other reliable income sources that can provide for your spouse, you could choose to maximize your pension benefit with a single-life annuity.
Some couples will use a portion of the difference between a single-life payout and a joint and survivor payout to purchase a life insurance policy. That policy can provide a larger spousal benefit and more flexibility in determining how the benefit can be used.
Another reason to choose the single-life option over a joint and survivor option is if you expect to outlive your spouse. Keep in mind that if you are the first to die, the payments will stop.
50 Percent Joint and Survivor Option
The 50 percent joint and survivor pension payout option pays a reduced benefit, but it pays half that benefit to the surviving spouse. For example, if the single life monthly payout is $2,800, the 50 percent joint and survivor option might be reduced to $2,300. However, at your death, your spouse will continue to receive $1,150 a month for life.
When to choose the 50 percent Joint and Survivor option
The 50 percent joint and survivor pension payout option is suited for married couples where the spouse depends on the pension income. It’s not always the best pension payout option for every couple, but it’s a common and effective choice. It’s especially appropriate if you are the older spouse or if your spouse is in better health than you.
100 Percent Joint and Survivor Option
Instead of paying a surviving spouse 50 percent of the reduced pension amount, a 100 percent joint and survivor option pays 100 percent. To cover the higher survivor benefit, the pension amount paid to the pension-holder is reduced further.
A single-life payout of $2,800 might be reduced to $2,100. The upside is that your spouse won’t experience any change in income from the pension. They will continue to receive the same $2,100 monthly benefit.
When to choose the 100% Joint and Survivor option
This option provides the most protection for your spouse, so it’s another common pension payout option for couples. This option is suitable if you are older or less healthy than your spouse, and there isn’t another income source.
Life with 10 Years Certain Option
This option has the second highest payout, but it also provides the least amount of protection for a surviving spouse. The life with 10-years certain option makes monthly payments for life. However, if you die in the first ten years, your spouse receives the same payout for the remainder of the ten years.
When to Choose the Life with 10 Years Certain Option
This option is appropriate if your spouse is significantly older than you or if their health condition makes it unlikely he or she will survive the 10-year period. It’s an important option to keep in mind if those scenarios apply to you. However, it has clear downsides when your partner is relatively young and in good health.
Pension Payout Option: The Most Important Financial Decision You Make
Your pension benefit is likely a major cornerstone of your retirement income plan, and you only get one chance to choose the right option. Once the payout begins, your choice is irrevocable.
That means you have a single opportunity to choose your pension payout option, and it requires you to, in a sense, predict the future. While no one can be certain about what the future holds, it is possible to consider what’s likely to happen.
So, you must weigh your options thoroughly in light of your cash flow needs as well as your and your spouse’s age and health circumstances.
Lump-Sum Benefit Option
As you make your choice about which pension payout option is best for you and your spouse as a couple, it can help to see the pros and cons for each listed succinctly. Use the following lists as a quick reference as you make your decision.
Pros of Lump-Sum Pension Payouts
- You can control investment decisions or hire an investment manager.
- Your investments could outperform the pension option, and you can increase your retirement income.
- If your investments perform well, you could increase the assets available for your heirs.
- Don’t have the rely on your company funding the pension plan
Cons
- You are responsible for creating sufficient lifetime income — you lose the security of a long-term, guaranteed pension payout.
- Bad investment choices or poor market conditions could threaten your financial security.
- If you fail to roll your lump-sum proceeds directly into an IRA, the entire amount could be taxed at your ordinary income tax rate.
- Any withdrawals you make from an IRA rollover before age 59 ½ are subject to taxes and a 10 percent penalty.
Long-Term Pension Benefit Options
Pros
- You receive a guaranteed monthly income you can’t outlive.
- For a reduced benefit amount, your spouse can receive a lifetime spousal benefit after you die.
- You have several options for selecting a payout, which can make it easier to find the best pension payout option for you and your spouse specifically.
Cons
- You do not have control over investment decisions and may have to adjust your budget to align with your pension payout.
- Typically, the benefit amount does not include inflation protection, which means you risk the loss of purchasing power.
- That lifetime income guarantee is only as good as your former company’s financial strength (though it is at least partially protected by the Pension Benefit Guaranty Corporation (PBGC).
Your pension benefit is the culmination of years of hard work. Your most difficult decision – choosing the best pension payout option for you and your spouse – still lies ahead.
You only get one chance to check the right box because there’s no going back once you receive a payment. It’s important to know your options.
More importantly, it is essential first to understand your circumstances and all the critical factors that will inform your decision. Working alongside an experienced retirement income advisor, you can thoroughly assess your financial circumstances in light of your cash flow needs.
Ultimately, you and your partner can arrive at a pension payout solution that maximizes your retirement income while protecting your financial security as a couple.
