Comparing the choices for your defined benefit/pension payout may help you figure out how to reach your retirement goals.
As you get closer to retirement, the reality of balancing your post-work budget with income from your retirement savings can feel stressful. How much will you really spend? How much do you really need to withdraw—and will those savings last? How do you even start to plan?
One good entry point: Evaluate your income sources—Social Security and 401(k) payouts, for example—as well as options from a defined benefit plan, commonly called a pension plan. Comparing the defined benefit/pension payout options may help you figure out a retirement budget that works best for your needs and goals. Here’s how to get started.
What are some key defined pension or benefit terms to understand?
Let’s start by reviewing a few of the terms you’ll encounter during your decision-making process for defined benefit/pension distributions. Some may be familiar to you, but some may not.
- Defined benefit/pension plan: A retirement savings plan typically funded entirely, or almost entirely, by your employer. Benefits depend on a combination of factors that typically include your service/employment time, salary, and age.
- Distribution/payout: The method of payment you choose and the amount you receive from your defined benefit plan.
- Alternate payee/beneficiary: A second person who may receive benefits, should your plan allow it and should you elect an eligible payout method.
- Actual retirement date: The date at which you choose to take your first payout from your defined benefit plan.
What are the types of defined benefit/pension distributions/payouts?
You can typically choose one of two options for a defined benefit/pension payout:
- An annuity distribution provides pre-set payments over a predetermined time span.
- A defined benefit lump sum distribution is simply that—a single payment.
Why would I choose a defined benefit/pension annuity distribution?
For some retirees, the appeal of an annuity distribution is certainty: It’s a fixed, regular payment made to you each month, no matter what. It’s almost like you’re replacing a portion of your pre-retirement income.
The specifics of your plan may vary, but in general, if you choose an annuity distribution three options may be available:
- Single-life annuity payments that end when you die.
- Period-certain payouts that continue for a certain time span. If you die during that time, those payouts continue to a spouse or beneficiary (sometimes called an alternate payee/beneficiary) until the end of the payout period.
- Joint and survivor payouts that are made for your lifetime plus the lifetime of another person, i.e., an alternate payee/beneficiary.
Tip: Both period-certain and joint and survivor payouts are lower than single-life payouts because they’re typically made over a longer payout period.
Two considerations: Because annuity payments are fixed, periods of high inflation will adversely affect buying power—those dollars are essentially worth less when prices are high. And these annuity payments are considered taxable income.
Why would I choose a defined benefit/pension lump sum distribution?
A lump sum distribution, which is just one, single payment, offers a level of control over your money: You may invest it or move it to another retirement account, or simply cash it out. (The choice will affect taxes, though; see below for more details.)
However, since a lump sum distribution is not regular, monthly payouts, you have to take on the responsibility of deciding how much to withdraw from available retirement savings and how to budget accordingly. And if you choose to invest the funds, you don’t necessarily have a guarantee of growth—the money may be worth less if there’s a period of market downturn, for example.
What can I do with a lump sum distribution?
If you choose a lump sum distribution, you can do a couple of things with the money.
- Roll the funds into a new or existing individual retirement account (IRA).
- You won’t pay taxes on the taxable portion until you begin withdrawing funds from the IRA (as long as you meet age minimums). If you don’t need the money immediately, you may have growth potential with your consolidated investments.
- Roll the funds into a qualified retirement plan like a 401(k).
- As with an IRA, this option helps you defer taxes until you begin withdrawing funds, and you may have investment growth potential. Check with your human resources department to see if any 401(k) rollover fees apply.
- Deposit the funds into a bank account.
- You’ll have immediate access to the funds. But the payout amount will be reduced by 20% for federal income tax and any state tax, if applicable, as well as a 10% penalty if you’re under age 59½. In addition, because the payout was made as cash to you, it may impact your current-year tax bracket. And you’ll have to manage how you budget the funds for retirement.
When will my defined benefit/pension payout start and how much will it be?
When you decide to start receiving payouts, you’ll establish an actual retirement date; that’s the date of the first payment of your defined benefit/pension plan. Many defined benefit/pension plans begin payouts at a traditional retirement age like 65, while some may allow you to elect a start date. If you retire early, your benefit may be reduced; if you retire later, it may be increased.
Every plan also has its own eligibility requirements and payout calculations, which are typically a combination of length of service, salary, and age. Whether you choose an annuity distribution or lump sum distribution, check with your human resources department for specifics on your payout based on your actual retirement date.
What are some key questions to ask myself before choosing a defined benefit/pension plan distribution?
- What options does your plan allow?
- Do you want or need monthly retirement income, or do you want a lump sum to do with as you wish?
- Do you want to provide benefits for a surviving spouse after you’ve died?
What’s next?
What options does your defined benefit plan allow? Log in to check the specifics of your account. Ready to make a distribution option? You can select that during log in, too. And if you need to set up an individual retirement account, we can help.
