A pension earned during your working years will obviously have a beneficial impact on your income in retirement. But there’s more to properly preparing for your pension than simply anticipating an eventual payout.
“Your pension decision will affect you, your spouse, and your heirs for the rest of your life,” says Matthew Mozer, CFP®, Vice President and Wealth Planner for Wells Fargo Private Bank. “It will have a significant impact on areas of your financial life, including cash flow, income taxes, investment allocations, and estate planning.”
That’s why Mozer recommends starting the conversation about your pension with your wealth advisor long before retirement. Every three to five years, plan to review the status of your pension together to forecast results. This will help you determine what the benefits might be, which can help you choose between your two payout options: annualized payments or a lump sum.
Annualized payments can help your monthly cash flow
“Cash flow plays a crucial role in deciding the payout option you choose,” says Mozer. “Once the weekly or monthly paycheck goes away at the start of retirement, most retirees will need other sources of income to support their living expenses.”
As Mozer explains, an annualized pension provides an ongoing fixed monthly income, typically until your death. However, you can often elect a joint and survivor option so that the monthly payment will continue to be paid over your surviving spouse’s lifetime, enabling them to receive anywhere from 50 to 100 percent of the benefit. This could be an important option if you’re interested in annualized payments and you have a known health issue that could shorten your life span. “A fixed and guaranteed monthly benefit is reassuring and helps provide some financial security,” says Mozer. “But it’s important to keep in mind that inflation can erode the fixed amount’s purchasing power over time.”
“Your pension decision will affect you, your spouse, and your heirs for the rest of your life.” — Matthew Mozer, CFP®, Vice President and Wealth Planner, Wells Fargo Private Bank
The lump-sum option can give you more control over the assets
If you have other cash flow means in retirement, choosing the lump sum payment option could be a smart choice as it lets you roll the lump sum into an IRA to continue to defer income taxes, explains Mozer. With this option, you control when you receive the income until you reach your required minimum distribution age (70.5 years). Any assets remaining at your death can then be bequeathed to your beneficiaries.
“The lump sum will provide you greater flexibility to take distributions if you need more income than under the annualized payout,” he says. “But be careful: you may run the risk of exhausting the lump sum funds prematurely without proper planning.”
Seven pension questions to ask your wealth advisor
Mozer recommends these questions as a starting point when discussing your pension with your wealth advisor:
- When is the earliest I can receive my pension?
- Is there a reduction in benefits if I receive my pension before a certain time?
- What are the advantages and disadvantages for me if I elect to receive my pension as a lump sum payment or as annualized payments?
- How should my health fit into my decision?
- What are joint and survivor payment options with my pension? How would choosing a joint and survivor payment option impact my monthly benefit?
- When I pass away, can my spouse continue to receive annualized payments?
- How do investments of my pension benefit affect my decision?