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How a Pension Works Once You Retire

Pensions today are quite rare so if you are covered by one, you are lucky. For a long time, pensions were standard options offered by most companies in America. Today, 20% of American professionals in the private sector can rely upon pensions for their retirement.

Pensions have grown less common due to their cost and longevity. Pension plans often continue long after an employee has retired, thus increasing liabilities on a company’s balance sheet. In recent years, individuals with pension plans have had to contribute more to their own pension plans to fund their retirement.

Offering pension plans was part of the employment hiring process for many older companies. Some of these companies have gone bankrupt. Newer companies today that were started in the last 40 years are not tied to these older benefit plans and have chosen to go a different route. (For more, see: How Do Pension Funds Work?)

If you have a pension plan, you do have options to consider. While pension documents can be lengthy to read, it is important that you know the essentials so that you can make the best decision for yourself.

Annuity or Lump-Sum Payment

You can receive your payment either as an annuity or lump-sum payment. Once you choose your option you cannot change it later, so choose wisely. Often, companies prefer that you take the lump-sum option because it is a simple, one-time transaction and your pension payment is no longer a liability on their balance sheets. A lump-sum payment is one large payment given to you right away.

With an annuity payment option, you receive multiple, smaller payments over years and possibly decades. Since your annuity can take a long time to pay off, companies often prefer the lump-sum payment. However, for you, an annuity option may make more sense.

Deciding which type of payment to take depends on how you intend to use the money. If you need a regular payment to supplement your income in retirement, the annuity payment option will make more sense for you.

If you do not need a regular payment to supplement your income in retirement, you may want to do the lump-sump payment. You could give a lump-sum payment to your children or heirs, stow it away for future medical expenses, use it to pay off a mortgage or debts, or utilize it to have cash available during your retirement.

Types of Benefits: Single or Joint

You can receive the highest monthly benefit through a single-life annuity, which is ideal if you are single. If you are married, you may want to do a joint pension. With joint pension plans, you can decide to take a higher or lower payment at first and then transfer the payout to your spouse if you pass away first. (For more, see: How Safe Is Your Pension?)

Some individuals with a pension plan choose to do the single-life benefit plan and then purchase an additional life insurance plan to give the surviving spouse the same payout. This can be helpful if the cost of the life insurance premium is less than the difference between the higher payout for the single life annuity and the joint annuity’s lower amount.

A Pension Isn't Necessarily Guaranteed

While receiving an annuity may be more beneficial for you in the long term, you still want to keep an eye on the company where you used to work to make sure it is not under financial duress and that your payout will still be made. Plans that are funded less than 80% or that consist of multi-employers often face funding gaps.

Companies usually pay premiums to the Pension Benefit Guaranty Corporation to insure their pensions. This means that you will still receive your pension even if the company runs out of money. If a company goes bankrupt, the Pension Benefit Guaranty Corporation would then step in and pay the pension (for up to $60,136 annually) from the age of 65 onwards.

Investing Pension Payouts

Some recipients of pensions choose to invest their funds instead of using them for living income. It is advisable to seek out a reputable financial advisor to assist you with coming up with a feasible plan. This may entail receiving dividend income from your investments that you can use on a monthly basis while you invest.

For those lucky enough to have a pension today, be sure to educate yourself on how they work once you are retired to ensure that you are taking full advantage of these now uncommon retirement plans. (For more from this author, see: How to Save for Retirement Without a 401(k).)