Last Updated: September 27, 2010
By FPA Member Amy Jo Lauber, CFP®
There are many people who are employed by companies, governments, or non-profit organizations that will receive a traditional pension plan, also called a "defined benefit" program. Selecting how to receive a pension benefit is difficult, and it is also an irrevocable decision.
A financial planner can help you understand your options and select the option that will be most beneficial, given your particular situation. For example, the planner will come to understand your goals for retirement income, survivor income (for a spouse or a dependent) and estate bequests. They will also learn about your health status and projected longevity, your risk tolerance, and the tax treatment of pension income in your state of domicile.
All pension plans offer a life only (or maximum) option as well as at least a few joint and survivor options. Some pension plans may allow you to take a lump sum and roll it over to an Individual Retirement Account (IRA). The life-only option provides the retiree with lifetime income and is generally appropriate for those individuals who are single or who do not have any specific goals to leave assets to their heirs. This option may also be appropriate for married individuals if they have adequate assets and/or life insurance to provide for their surviving spouse or dependent child(ren). Some pension plans offer life options with "term certain" periods. These term certain options ensure that the retiree receives a lifetime income and, in the event of his/her death during the term, the pension payment continues to the designated beneficiary for the remainder of the term. Typical term certain periods include five- and ten-year certain.
A joint and survivor option provides the retired employee with a lifetime income but upon his/her death, a percentage of the pension continues to be paid to the surviving spouse for his/her lifetime. This option reduces the retiree's pension payment because it essentially purchases an annuity for the surviving spouse. Once again, if the retired employee has enough assets and/or life insurance, this option may not be necessary and may be expensive (in terms of the reduced pension payment). Typical joint and survivor option percentages are 50 percent, 75 percent and 100 percent.
As mentioned earlier, some pension plans allow you to take a lump sum payment of your pension and roll it over to an IRA. This may be a beneficial option for those who would like to invest their pension dollars, either themselves or with a professional money manager. Careful beneficiary planning is crucial, as is a clear understanding of the RMD or Required Minimum Distribution rules that commence about the time a retiree is age 70 1/2. Pension payments are guaranteed for life; IRA distributions are not, but they can be stabilized using some portfolio management strategies and/or immediate annuities.
Selecting a pension option takes time, careful analysis and consideration. Your financial planner can help reduce the guesswork with this important decision.
FPA member Amy Jo Lauber, CFP®, President, Lauber Financial Planning, Buffalo, NY.