As you approach retirement age, one of the critical decisions you must make is how to receive your retirement benefits. Two standard options are annuity and pension plans. Many ask the question, is a pension the same as an annuity? However, these plans offer different benefits and risks, making deciding which is best for you challenging. This annuity vs. pension plan comparison will explore the differences between annuity and pension plans and help you decide which is correct.
- Understanding Annuities
- Which Has Been Around Longer? Annuities Or Pensions?
- Annuity vs. Pension
- Advantages of Rolling Pension Lump Sum into a Deferred Annuity with a Lifetime Income Rider
- Is A Pension An Annuity?
- Pension Payouts Options
- Can I Move My Pension?
- Pension Vs. Annuity: Pros And Cons
- Death Benefits
- Flexibility
- Compare The Payout Between An Annuity And A Pension
- Next Steps
- Related Reading
- Request A Quote
Understanding Annuities
An annuity is a financial product that provides a guaranteed income stream over a set period. Insurance companies typically offer it, which can be purchased with a lump sum payment. The income received from an annuity can be paid out over the annuitant’s lifetime or for a set period. In addition, the payments received from an annuity can be fixed or variable, depending on the type purchased.
Types of Annuities
There are several types of annuities available, including fixed annuities, variable annuities, indexed annuities, and immediate annuities. Each type of annuity offers different benefits and risks, depending on the individual’s financial goals and risk tolerance.
Benefits of Annuities
Annuities provide a guaranteed income stream for a set period, which can provide financial security in retirement. Additionally, annuities can offer tax-deferred growth, meaning that the money invested in the annuity grows tax-free until withdrawals are made.
Which Has Been Around Longer? Annuities Or Pensions?
Annuities have existed since Roman times, originating over 2,000 years ago with “annua,” annual payments made for life. Pensions, in some form, can be traced back to ancient Roman soldiers receiving compensation for their service. However, modern state-sponsored pension systems began in the late 19th century, with Germany introducing the first comprehensive system in 1889 under Chancellor Otto von Bismarck.
Annuity vs. Pension
When deciding between an annuity and a pension, it is essential to consider several factors, including the individual’s financial goals, risk tolerance, and retirement needs.
Benefits of Annuities vs. Pensions
Annuities offer flexibility in terms of payout options and can provide tax-deferred growth. In contrast, pensions offer a guaranteed income stream and are typically funded by both the employer and the employee.
Risks of Annuities vs. Pensions
Annuities carry the risk of the insurance company’s solvency and potential fees, while pensions can be impacted by the employer’s financial stability and economic changes.
Advantages of Rolling Pension Lump Sum into a Deferred Annuity with a Lifetime Income Rider
Many can choose between a lump sum payout or a lifetime income stream from an annuity. While both options have pros and cons, rolling the pension lump sum payout to a new deferred annuity with a lifetime income rider can be more beneficial than the pension annuity payout.
Growth Potential
Firstly, a deferred annuity with a lifetime income rider can provide a guaranteed income stream for life, similar to a pension payout, providing peace of mind and financial security in retirement. However, unlike a pension annuity payout, which is typically fixed, an annuity with a lifetime income rider allows for potential growth and can keep up with inflation, ensuring that the annuity’s value retains its value over time.
More Flexibility
Secondly, rolling the pension lump sum payout to a new deferred annuity allows for greater flexibility regarding when and how the income stream is received. With a pension annuity payout, the income stream typically starts immediately and is fixed for life, which can be limiting for those who want more control over their retirement income. In contrast, a deferred annuity allows you to delay the start of the income stream until a later date, which can be helpful if you plan to work or have other sources of retirement income in the near term.
Tax-Benefits
A deferred annuity with a lifetime income rider can also offer tax benefits. The annuity’s growth is tax-deferred until the income stream begins, which can help maximize the growth potential of the investment. Furthermore, a portion of the income stream received from the annuity may be considered a return of principal, which can reduce the tax liability of the annuitant.
More Control
Additionally, rolling the pension lump sum payout to a new deferred annuity with a lifetime income rider allows for greater control over the investment. An annuity with a lifetime income rider can offer various investment options, including fixed or variable, allowing investors to choose the option that best fits their risk tolerance and investment goals.
A Death Benefit For Beneficiaries
Finally, annuities typically come with a death benefit, which can provide financial security for loved ones in the event of the annuitant’s passing.
Is A Pension An Annuity?
A pension is an annuity, but not all annuities are pensions.
- A pension is a retirement plan offered by employers in which employees receive regular payments after retirement, typically for the rest of their lives.
- On the other hand, an annuity is a financial product that can be used for various purposes, including retirement planning. Annuities can be purchased from insurance companies and other financial institutions and structured in various ways.
Some annuities pay out a fixed amount of money each year for a fixed period of time, while others provide payments for as long as the annuitant lives. Some annuities offer variable payouts, meaning the amount received yearly can fluctuate based on investment performance.
While all pensions are annuities, not all annuities are pensions.
Pension Payouts Options
Pension plans utilize annuities to distribute income to their retired employees. The following are typical pension payout options:
- Life Annuities: A life annuity pension is a fixed-income contract in which an insurance company commits to paying income payments throughout the annuitant’s lifetime.
- Joint and Survivor Annuities: A joint and survivor annuity is a life annuity (two lifetimes) that provides income to the last surviving covered individual until death.
- Refund Annuities: A refund annuity is a contract that guarantees that a particular amount will be paid, no matter when the annuitant passes away.
Can I Move My Pension?
You can move your pension. Roll over a retirement account into an annuity with a guaranteed lifetime withdrawal benefit or start a new flexible premium annuity with an income rider. Either way, you will know today what your retirement income will be tomorrow at any given retirement age.
Pension Vs. Annuity: Pros And Cons
A pension becomes an annuity if a retiree elects the payment option (instead of the lump sum option). There are significant pros and cons when making this decision. Below is a “T-Chart” weighing both the good and the bad.
| Income Rider | Pension Income |
|---|---|
| Guaranteed income for life | Guaranteed income for life or fixed period |
| Flexibility to start/stop income stream | Potential higher payouts |
| Potential paycheck increases for inflation. | No additional fees |
| Costs range from no cost to 1.25% annually | Irrevocable payments |
| Potential to earn interest | It cannot be surrendered; No refunds. |
| Future income guaranteed today | Earns approximately 1% interest annually |
| Can be surrendered or cashed in | No liquidity |
| Lump-Sum Death Benefit | No death benefit or series of payments |
| Help with long-term care costs | It cannot help healthcare costs |
| Standard liquidity |
Lifetime Income Rider
An annuity with an income rider works similarly to a pension. An owner invests money toward their retirement planning, and the outcome is either a retirement income stream or a lump-sum payout.
The difference between the two retirement planning solutions is that the pension withdrawal offers an irrevocable income stream (annuity payments) for a specific period or lifetime(s) without flexibility. On the other hand, the annuity’s income rider distributes an income stream for life or both the owner’s and the owner’s spouse’s lifetimes with flexibility and liquidity.
Growth Potential
Growth potential in a pension (pension annuity rates) typically earns little to no interest after the pension income distribution phase begins. However, an annuity typically earns interest even after the retirement income distribution phase.
Layering With Social Security Benefits
Since most companies no longer offer a pension, the annuity fills that gap. So now, a retiree can layer an additional income stream besides their Social Security income.
Death Benefits
If the annuity owner dies while receiving payments, the designated beneficiaries may get some or all of the money left in the annuity in a lump sum. On the other hand, a pension beneficiary receives a series of payments or no death benefit at all.
Helpful Tip: If you have a pension with a single-life-only payout, there might not be a death benefit. Compare life insurance quotes to protect your estate in case of premature death.
Flexibility
A pension plan is an annuity that distributes income via annuitization, which is irrevocable. A deferred annuity’s income rider is flexible in that the payment can be turned on or off at any time and can be canceled.
Compare The Payout Between An Annuity And A Pension
Determine whether moving or staying with your pension is the right move. Our calculator below will estimate your annuity income if you move to a new annuity contract.
Note: You can purchase an annuity (with no tax penalties) with your pension lump-sum payout.
Next Steps
Deciding between an annuity and a pension can be challenging, and it is essential to consider all factors before making a decision. For example, annuities offer flexibility and tax-deferred growth, while pensions offer a guaranteed income stream and are typically funded by both the employer and employee. Therefore, it is essential to carefully evaluate each option and consider individual financial goals, risk tolerance, and retirement needs before deciding. Seeking our advice can also help ensure you make the best decision for your financial situation.
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Related Reading
- The benefits of owning an annuity
- What is a pension, and how does the plan work? Use our free pension calculator to determine which route your should go.