WHAT IS 'Pension Option'

Pension option refers to one of a series of choices that a pensioner must make as they approach retirement. These decisions determine where the cash pension payouts will go in the short term and how payments will be structured.

BREAKING DOWN 'Pension Option'

Pension option describes one of several options that a retiring employee must consider with regard to their pension assets. The options center on where the cash proceeds from the pensioner’s account will go, and how payouts to the pensioner will be structured.

The most consequential decision that many retiring employees face is whether to opt for a series of monthly payments from their pension or one lump-sum distribution at retirement.

Monthly payment pension option - pros and cons

The great advantage of receiving monthly distributions from a pension annuity lies in the predictability of these payments. Payments are guaranteed at a set amount until the death of the retiree. All investment risk is held by the pension plan, and payments are generally guaranteed by the Pension Benefit Guaranty Corporation (PBGC) in the event of the employer’s failure to meet its pension obligation.

Most plans allow for a spouse to continue receiving benefits after the employee’s death, but very few offer any benefit to beneficiaries beyond a spouse.

Lump-sum pension option - pros and cons

Typically, individuals taking the lump sum put the money into an individual retirement account (IRA) to avoid taxation and to seek further returns on their investments. By doing so, the retiree can take some control over investment choices, and upside growth is potentially significant. Loss is an option, too. It is likely that either the pensioner or the IRA balance will outlive the other. This means that the individual should have a backup resource and designated beneficiaries if a balance remains after death. IRAs offer greater flexibility in selecting beneficiaries than a pension annuity.

One common route for retirees selecting a lump sum distribution is an IRA annuity product. This functions similarly to the monthly distribution option described above, but some retirees feel that they can purchase a higher-performing annuity outside of the pension plan.

Annuity Pension Options

Retirees selecting monthly payments from a pension annuity or an IRA annuity will have to decide which type best fits their needs. A single-life annuity will provide the largest monthly payments, but these payments will end once the pensioner passes away. A joint-and-survivor annuity allows for a spouse to receive a pre-determined portion of the pension in monthly payments upon the participant’s death. Finally, a period-certain option specifies a time period over which payments will take place, and a third beneficiary can be named to receive payments if both the employee and the spouse have died.

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