What Is a Pension Option?

A pension option is any of a number of choices that an employee must make as they prepare for retirement. Their decisions determine how they receive the money in their pension accounts. Corporate employees offered a retirement pension instead of a 401(k) are decreasing in number, especially in the private business sector. However, many civil servants still receive pension benefits.

Key Takeaways

  • Typically, pensions are offered as a lump-sum payment or a lifetime monthly payment. 
  • It is possible to take less money from a pension option to provide a lifetime source of income for your spouse and yourself. 
  • Corporate pensions are rare. Most civil servants, however, receive pension benefits. 
  • A lump-sum payment from a pension usually goes into an IRA account. 
  • A monthly pension may provide the most reliable form of retirement income, as the amount stays the same throughout one's lifetime. 

Understanding Pension Options

One of the most important decisions is whether to take the money as a monthly payment or a lump-sum.

The Monthly Payment Option

Monthly payments are steady and predictable. The amount of the payment is set up front and based on the person's years of service and salary. Payments are guaranteed for life, usually with an option to cover both your and your spouse's lifetime at a somewhat lower rate.

All investment risk is on the company. That is, if you live to be 130, you may have exhausted your account long ago, but those payments will keep coming. Even if the employer fails to meet its obligations, the payments are generally guaranteed by the Pension Benefit Guaranty Corporation (PBGC).

When you pass away, your household will lose your pension income if you have not arranged to have your monthly pension cover your spouse.

The Lump-Sum Option

A lump-sum payment puts the responsibility and the risk on you. You get the total pension amount that is reserved for you, based on your life expectancy. You may then invest it, hopefully adding to your nest egg during your retirement years.

Typically, individuals taking the lump-sum put the money into an individual retirement account (IRA). By doing so, the retiree takes control of the investment choices. Substantial gains or losses are possible.

It is likely that either the retiree will outlive the IRA or vice versa. People who choose this option should have a backup resource if the assets in the IRA are exhausted. They also should designate a beneficiary in case there is a remaining balance.

One common route for retirees selecting a lump-sum distribution is an IRA annuity product. This functions in much the same way as the monthly pension distribution option, but is preferred by retirees who seek a higher-performing annuity outside of the pension plan.

Other Options

Retirees who select the monthly payment option, either through a pension plan or an IRA annuity, will have to decide which type best fits their needs.

  • A single-life annuity will provide the largest monthly payments.
  • A joint-and-survivor annuity arranges for a spouse to receive a pre-determined portion of the pension in monthly payments after the participant’s death.
  • A period-certain option specifies a time period over which payments will take place, with the opportunity to name a third beneficiary to receive payments if both spouses have died.