Set for Life Through Your Pension Plan?

The dos and don'ts of taking a pension.

You've worked hard all of your life. Now most of that work is behind you, and you're going to retire. This should be a time of celebration and of making plans to really enjoy life, right?

So why are you so nervous?

Probably because a host of decisions accompany retirement, and you don't want to blow it!

For those of you who are lucky enough to work for companies that still offer pension plans, you'll typically have the option to take a lump sum or to take an annuity. The lump sum is generally directly transferred into a traditional IRA (a "direct rollover"). If you choose to take your pension as an annuity, you'll receive an annual stream of income.

To make the "right" choice of which distribution option to take, consider the following:

DO...
Weigh your payout options. Typically, a plan will offer a payment for the duration of your life only, or a payout for you and someone else (generally your spouse). If you are planning for retirement as a couple, you need to think through what will happen when one of you dies. Frequently, neither spouse will want a drop in the amount of money coming in each month in the event of the death of the other. If this applies to you, the 100% joint-and-survivor pension may be the best choice. Under that option, the surviving spouse will receive 100% of what had been coming in after one spouse dies. If you choose a 50% joint-and-survivor pension, your spouse would get only 50% of what you had been receiving.

Consider how much flexibility you might need with your money. If you don't expect to buy many big-ticket items in retirement, an annuity may meet your needs by providing a steady paycheck every month. However, annuities don't typically offer much flexibility, so if you know you'll need access to larger amounts of money from time to time, you may be better off taking a lump sum and rolling it into an IRA. Ideally, if you take an annuity, you'll also have another pool of money you can tap if you need more than your regular check provides.

Know how much of your pension the PBGC (Pension Benefit Guaranty Corporation) covers. You may have some safety net when you choose an annuity over a lump sum. The PBGC--essentially a government-run insurance company covering pension plans--may cover all or a portion of your annuity if your company goes belly-up. You can check how much of your pension may be covered at the PBGC Web site. The maximum paid for an annuity over your life only (a "single life annuity") is $47,659 currently. This amount is lower if you begin receiving payments from PBGC before age 65 or if your pension includes benefits for a survivor or other beneficiary.

Consider taking an annuity if longevity runs in your family. When the actuaries figure out how much you'd get in a lump sum, they use average life-expectancy tables. If people in your family live to ripe old ages, you might be better off taking an annuity that will last as long as you do! That way, you know you'll never run out of money.

Watch interest rates. As interest rates rise, your lump-sum benefit may go down. (And if they fall, it could go up.) That's because one of the numbers used to calculate your benefit is an interest-rate factor. When you begin looking at retirement, be sure to understand how your lump-sum benefit might change given differing interest-rate scenarios.

DON'T...
Do what all your friends are doing without thinking through the consequences. At the end of the 1990s, a lot of retirees chose a lump sum from their pension plan instead of an annuity--often because that's what their friends were doing. After three rough years in the stock market, many of those people experienced significant losses investing their lump sums, and some have even had to go back to work.

Mess up paying your taxes. Paying taxes was simple when you were working, because your employer deducted what you owed directly from your paycheck. When you retire, you take over responsibility for arranging tax payments. Fortunately, most companies will withhold tax from your pension check if you ask. In some cases, you'll also need to pay estimated tax each quarter. You can find out more about estimated tax by visiting the IRS Web site.

Take a single-life annuity if longevity doesn't run in your family. A single-life annuity pays only as long as you're alive. If your family members tend to live shorter lives, your heirs may be better off with a lump-sum rollover. Or you can always choose a joint-and-survivor annuity that keeps paying your heirs after you are gone.

Forget that an annuity probably won't keep up with inflation. It's easy to forget the dangers of inflation since we've experienced relatively low rates recently. But that won't last forever. When inflation does rear its ugly head, an annuity probably won't keep pace. That's why it's best to keep a separate pool of money that can be invested as a hedge against inflation. If you have an option to choose an annuity that grows with inflation, you should strongly consider taking it even if your benefit starts off being somewhat less.