Pensions & Pension Annuities
A shrinking number of businesses, major corporations and governments still provide retirement security to workers via pensions. In some pension plans, workers can choose how to get their money – through a series of payments, in a lump sum or a combination of the two.
What Are Pensions?
Pensions are an employment benefit and a way for a company to help workers finance their retirement. Pension plans date back to ancient Rome, when soldiers received pensions after years of service. Pensions became popular in the United States when President Franklin Roosevelt introduced the world’s largest defined benefit pension plan in 1935 with the Social Security Administration.
As the American middle class grew following World War II, many employers offered pensions as an employee benefit.
Employers who make monthly payments to former workers use pension funds that both the employer and employees paid into during the years the employee was working.
Since the early 2000s, the number of workplace pension programs has dwindled; many companies found it difficult to fund pensions over a long period of time while also pleasing shareholders who wanted more profits and fewer long-term liabilities.
The bulk of employers today with pension plans are federal, state and local governments, and branches of the U.S military. Federal pensions serve 2.3 million active civilian employees. State and local pensions cover 14.8 million active participants. The government issues pensions in various forms, including defined benefit and defined contribution plans.
Some private companies and unions still offer pensions as a benefit, as well. Private sector pensions hold more than $2.2 trillion in assets and cover around 44 million working Americans.
Some employers use their money to fund and control pensions. Others work with insurance companies to set up third-party annuities for employees, which provide security and relieve the company of the long-term financial obligation. Companies that use pension annuities include Verizon, General Motors, Ford and Heinz.
Average Pension Benefits
Pension benefits vary widely, often based on the type of employer, industry and location. According to data from the Pension Rights Center, one third of U.S. seniors in 2015 received retirement income from a pension.
- Federal government pensions
- Railroad pensions
- Military pensions
- Local or state government pensions
- Private pensions and annuities
Annuities vs. Pensions
Along with Social Security benefits, retirees rely on pensions and annuities — both tax-deferred benefits — to afford living expenses once they stop working.
Similar to a life or longevity annuity, pension payouts begin close to or at retirement and usually last until the recipient’s death. In some cases, the worker may name their spouse as a beneficiary of the pension in the case of their death.
Investment annuities are another type of financial product that pays in installments. Examples include single premium annuities or variable annuities. Unlike pensions, people purchase annuities independently, and they’re not linked to an employer. People who have input all the money allowable into 401(k)s and IRAs and still have money they want to save for retirement typically purchase investment annuities. They contact a broker and buy investment annuities. Those annuities then grow, tax-free, until retirement.
The Secure Act has made it easier for employers to allow annuity options in 401(k) plans.
Defined Benefit vs. Defined Contribution Plans
The main difference between defined benefit (DB) plans and defined contribution (DC) plans are where the money comes from.
In a defined benefit plan, the employer contributes the money to the pension, which the employee receives on retiring. DBs are based on a fixed sum and are guaranteed to pay out to employees, regardless of how the business is performing financially. This is because the Pension Benefit Guarantee Corporation — a federal agency created following the Employee Retirement Income Security Act — helps protect pension funds.
In addition, the Employee Retirement Income Security Act of 1974 mandates qualified pre-retirement survivor annuity (QPSA) as protection to the spouse of a pension plan participant if the participant dies before he or she retires.
Companies often have difficulty maintaining DB plans because they carry the financial burden. If inflation occurs, the stock market drops or the company revenue is declining, they may have to pay for the pension with out-of-pocket funds.
As a result, many employers are now choosing DC plans because they do not require as much of a financial investment from the company. In these plans, such as IRAs and 401(k)s, the employee is responsible for adding money to the account. In some cases, employers may offer a small matching program to incentivize employees to save for retirement. IRA and 401(k) plans are advantageous because they allow employees to earn tax-deferred growth on their savings.
Pension Payments and Lump Sums
Pension owners often hit a crossroads when they retire. Somewhere between ages 55 and 65, they’ll have to decide whether they want a lump sum payout, a series of payments or a combination of the two. Most companies default to a series of pension payments, requiring the employee to opt out of the plan before retirement if they want to receive a lump sum. Those who elect a lump sum may receive a check for the full amount or roll the total into an eligible tax-free or tax-deferred plan, such as an IRA.
- Access money for large purchases
- Potential for putting cash toward high-yield investments
- Prevent payments from losing value because of inflation
- Money may not last long if spent all at once
- Financial illiteracy may lead to poor investment of funds and loss of capital over time
- Choosing an annuity provides security but less flexibility
- Guaranteed income for life
- Taxes spread out over time
- Equal monthly payments may not account for an increased cost of living
- Much of your pension is reliant on the financial health of your former employer’s pension fund
- Your investment may not be readily accessible because of surrender charges
- Balance immediate and future expenses
- Access a large portion of pension for medical bills and other needs
- Reliable income over time
By law, a pension plan must provide a lifetime annuity option that pays benefits until you die or until a surviving beneficiary passes away. Your plan may offer a lump sum option in lieu of, or in addition to, a life annuity.
- How long will my spouse live? A lump sum may not last long enough if the pension recipient or their spouse has a high life expectancy.
- How much can I afford to lose? Those without other wealth may benefit the most from payments rather than lump sum.
- Can I skillfully invest the money? If you or your spouse is a savvy investor, taking a lump sum and investing it wisely could result in more accumulated wealth in the long run.
Comparing Lifetime Payments and Lump Sum
- Yes, on a regular basis through the end of your life.
- Lump Sum
- Yes, only once.
- Maybe. If your pension payments factor in cost-of-living adjustments, then yes. If your pension payments are fixed, then no
- Lump Sum
- Possibly, if invested in a conservative stock portfolio that grows over time to accommodate increased cost-of-living.
- Lump Sum
- No, the employer or insurance agency does this.
- Lump Sum
- Yes, if you choose to.
- Yes, if you have a “joint and survivor” pension annuity.
- Lump Sum
- Yes, if your beneficiary makes a claim with your employer to receive the benefits.
Pensions for Teachers
Teachers of all grades, from kindergarten to law school and medical school, are a large group of American working professionals who usually are eligible to collect pensions after they retire. This mostly affects public school teachers who draw years of income through school systems that participate in county or state retirement systems. These pensions differ from state to state but are generally referred to as Public Employee Retirement Systems and Teachers Retirement Systems.
Some states automatically withhold a portion of a teacher’s paycheck and then contribute another portion to a retirement fund. In other states, teachers must work at least 10 years before they’re allowed to allocate pre-tax dollars to retirement plans. Teachers, school administrators, county and state admin, and executive staffers who work 25 to 30 years in a public school system gain the greatest benefit from these systems, which tend to reward same-school and same-system tenure.
This is especially true for athletic coaches, some of whom tend to migrate from school to school and state to state over a long career. In some cases, the stringent requirements for attaining full pension benefits make private sector jobs more appealing. However, private-sector teaching jobs are more likely not to have DB pension plans. Instead, they offer DC pension options such as IRAs or 401(k)s.
While critics worry about the long-term sustainability of some state education pension systems, right now these payments are still a guaranteed benefit for educators. Teachers needing money from their pension savings can contact pension purchasers and sell payments in exchange for a cash advance.
Pensions for Veterans
Those who serve in the military and meet certain qualifications may qualify for the Veterans Pension, which is a monthly monetary benefit that is tax-free. The Veterans Pension is also need-based, meaning only those who meet a certain level of income qualify for the benefit.
Those minimum requirements include at least 90 days of active duty during a wartime period (WWI, WWII, Korean War, Vietnam War or the Gulf War) or at least 24 months if you entered active duty after Sept. 7, 1980.
- Age 65 or older, or
- Completely and permanently disabled, or
- A nursing home patient receiving skilled nursing care, or
- Receiving Social Security Disability Insurance (SSDI), or
- Receiving Social Security Income (SSI)
Also available to families of veterans is the Survivors Pension. This program is available for low-income, unmarried surviving spouses or unmarried children of deceased veterans. Veterans and survivors with additional needs, who require assistance or must remain at home, can apply for supplemental income such as Aid & Attendance (AA) and Housebound plans.
Selling Pension Payments & Lump Sum Advances
Pension recipients may be able to find buyers offering a lump sum in exchange for future payments, but the transfer is not as simple as selling single premium annuities or structured settlements.
For example, federal law prohibits assigning of military and civil service pensions, and the IRS code prohibits the sale of some private pensions. Both the Securities and Exchange Commission and the Financial Industry Regulatory Authority have alerted pensioners to be wary about accepting cash buyouts.
However, a select amount of funding companies will purchase pension payments in exchange for a lump sum. Companies that buy pensions refer to the practice as factoring or setting up mirrored pensions, pension income programs, pension advance, pension loans or secondary-market annuities.
2 Cited Research Articles
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- Internal Revenue Service. (2016, November 17). Retirement Topics - Death. Retrieved from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-death
- Pension Rights Center. (n.d.). Income from Pensions. Retrieved from http://www.pensionrights.org/publications/statistic/income-pensions