What Is a Pension Option?

The term pension option refers to a series of choices that an employee must make to prepare for retirement. The decisions that an individual makes determine how they receive the money in their pension accounts. Employees can choose a single payment or having their pension stretched out to provide them with regular monthly income. Pension options are frequently available for civil servants but may also be offered by corporations to their employees.

Key Takeaways

  • Employees are required to make choices known as pension options in order to prepare for retirement.
  • The majority of pension options are offered through the public sector or government jobs.
  • Employees can choose between single life, joint life, or temporary annuity options.
  • Individuals should consider factors that affect their personal situations, including their age and that of their spouse, their financial situation, and future goals.
  • Pension option payouts can be made monthly or in a single lump sum.

Understanding Pension Options

Pensions are retirement plans. Employers make contributions to pension plans for the benefit of their employees' futures. These contributions are divided into a pool of funds, which are invested on behalf of workers. Interest and earnings generated from these investments lead to income for employees.

Pension options can be divided into a few payout plans. These include:

  • Single life options: This option is designed for single individuals or those whose spouses give up any rights to inherit their pensions.
  • Joint life options: These pension options make monthly payments and are guaranteed for the lifetime of individuals and their spouses.
  • Temporary annuity options: This choice provides a top-up for those who retire before the age of 65.

As noted above, pension options are commonly offered to civil servants by various levels of government or those who work in the public sector. Corporate employees may also be offered pension options through pension plans. But these retirement plans are being eclipsed in the corporate world by 401(k)s. These are tax-advantaged retirement plans that use defined contributions to provide future income for employees once they retire.

When you pass away, your household will lose your pension income if you don't arrange to have your monthly pension cover your spouse.

Special Considerations

There are a few important factors that individuals should consider before they settle on a pension option for their retirement. Some of these include:

  • their age
  • the age of their spouse
  • their personal financial goals
  • the needs and goals of their dependents
  • their financial status and situation
  • their life expectancy

Once these are noted, it becomes easier to narrow down the best option to ensure that pension payouts are seamless.

Types of Pension Options

As stated in the previous section, individuals have a few payout options available with respect to their pension options. One of the most important decisions is whether to take the money as a monthly or lump-sum payment option. We've listed the most common options below.

Monthly Payment Option

Monthly payments are steady and predictable. The payment amount is set from the beginning and is based on an individual'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 of the 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).

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 in order to add to your nest egg during your retirement years. Individuals who take the lump sum typically put the money into an individual retirement account (IRA). This allows the retiree to take 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 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.