The Pros and Cons of Pensions vs. Annuities
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Date: September 30, 2016
Many companies offer employees a choice between monthly annuity payments or one-time lump-sum retirement accounts from which they can draw pension payments as necessary. These two retirement options are very different and your choice can impact your future financial security.
Annuities are payments of a set amount that you are guaranteed to get every month during your retirement. A lump sum pension is a large amount of capital from which you can take pension payments as you need them.
If you are trying to decide between an income annuity and an account-based pension, you must determine what you value more: income security or access to your savings and the ability to keep them growing.
Annuities Provide Stable Income
Most people want a stable stream of income to fund their retirement years. If income stability is your top priority, consider the income annuities option. Annuities provide you with set income payments during your retirement. You are guaranteed to receive this set monthly amount over a specified period of time, regardless of what the stock and bond markets are doing. If you have a lifetime annuity, you'll receive the set payment every month as long as you live. If you have a term-certain annuity, you'll receive the payment only for the term set out in the contract, such as 20 years.
Annuities Allow No Access to Capital
The downside to taking your retirement in an income annuity is that you lose all access to the pool of capital. You're paid the agreed-upon monthly sum, but the rest of the retirement money is beyond your reach. You can't take out more than the amount of your monthly check, nor do you have any say in how the rest of the money is invested.
Pensions Offer Access to Capital but Less Income Stability
Account-based pensions are exactly the opposite of annuities in terms of advantages and disadvantages. You'll have access to your money, but you'll have less income stability. If you decide to take the lump-sum pension and fund your retirement from it, you essentially leave the lump-sum in one account and draw monthly payments from it. You can change the amount you draw, or you can take a bigger sum, such as to fund that vacation house.
You also decide how the account should be invested. This is nice when your investments increase in value, but not so nice when they decrease. You may not have enough money to provide for the monthly payments throughout your lifetime if you make bad decisions that cause the principal to go down.
Options for Building Stable Income
"Stable income is a critical part of a portfolio," according to Robert Schmansky, personal financial advisor and founder of Clear Financial Advisors, LLC. "Whether it is from annuity or pension income, or from short-term, high-quality bond mutual funds, it is crucial to have years' worth of income in assets that won't fluctuate with markets."
Schmansky suggests that those taking account-based pensions set aside a part of the account for short-term needs to meet expenses for the next seven years. This portion of the account, he says, should be diversified in high quality, short-duration bond funds. The rest of the money should be invested in a mix of real assets and stocks that will provide inflation protection.
"For many, that may mean having a significant amount in the markets during retirement, and that's where we see the benefits of pensions," Schmansky explains. "Those with a good pension have choices in retirement to maintain their holdings during market declines."