Pension vs Annuity – Which is better?
What is better when it comes to the pension vs annuity dilemma?
Annuities have become a more popular option of the two due to the variety of benefits and tailored solutions to individual circumstances, while pensions remain to be mostly reserved for the government, military, and other state jobs.
Still, everyone’s needs are different. When developing your retirement income plan, you want to get a complete understanding of all the options and schemes available to you.
Pensions and annuities bring along different kinds of perks, and each has its own disadvantages, too. To help you make an informed decision, we’ve dissected both terms and compared them side by side.
By the end of the article, you’ll understand everything that comes with pension payments on the one hand and annuity payments on the other.
What Is a Pension? Understanding Pension Payments
A pension is a type of retirement savings plan that some companies offer to their employees. This means that the employer creates and manages a pension fund, i.e., a retirement account, for their employee. In this sense, a pension is similar to social security benefits.
After the employee retires, they can start receiving payments from the pension funds. The pension amount itself depends on individual factors, such as age, length of employment, salary, and so on.
Today, pension funds are the most common form of retirement funds for government jobs. Private-sector pensions are less frequent due to the fact that private companies rarely offer pensions to their employees.
Advantages of Pensions
Considering that your employer deals with the day-to-day maintenance of your retirement account, all the money, contributions, and payouts, a traditional pension plan means you don’t have to worry about any contracts or agreements.
You automatically get regular payments without having to do much on your part, just like with social security payments. This is the major advantage of pensions.
Also, once you start payments, you’re insured by the Pension Benefit Guaranty Corporation (PBGC) and protected by federal law. The Pension Benefits Guaranty Corporation means that you are guaranteed your payments even if your company cannot make them or declares bankruptcy.
Disadvantages of Pensions
As mentioned above, the fact that your employer is in charge of pension payments can be seen as an advantage in that you don’t have to think about any details or take an action itself.
However, it can also be seen as a disadvantage. When your employer is entirely responsible for the payment and your pension fund, there is less transparency about the pension amount and the whole retirement process. The company’s claims-paying ability also has to be considered.
Types of Pension Schemes
There are two main types of pension schemes: a defined contribution plan and a defined benefit plan.
A defined benefit plan is that the traditional pension fund in which the employer guarantees a specific retirement benefit.
On the other hand, defined contribution plans – like 401 (k) – are usually based on the employee’s gross salary, the employee chooses investments, and the company can match the contribution up to a certain limit.
Also, people can choose between taking their pension as a monthly payment or as a lump-sum payout.
What Is an Annuity?
An Annuity is an insurance product that people purchase by signing a contract with an insurance company (sometimes known as the pension annuity) – typically, a life insurance company.
You fund the investment in your annuity pension, either through a lump-sum payment or periodic payments. You can make contributions from different kinds of sources, including personal savings, IRA rollover, or ever an employer-sponsored retirement plan.
The insurer invests your money in the stock, mutual funds, or bonds. Depending on the type of annuity pension, the income annuity amount can be affected by the stock market or the interest rates.
As stated in your specific annuity scheme agreement, you will start receiving payments in retirement or sooner, in a lump sum or regular payments.
Bottom line – annuities offer a steady income stream, but there are a lot of types to choose from (and we will explain them below for your convenience).
Advantages of Annuity
The biggest advantage of an annuity is that you’re in charge of your pension fund.
You dictate all the factors you want to have in your lifetime income stream – including the amount, growth, and payment options.
For instance, individuals can structure the payment as “single life” that ends after death or “joint life” that continues to provide financial support for the family.
Also, in the event that you fund your annuity with after-tax regular income, then you will only pay taxes on the gains when you receive that money later on.
All in all, annuity equals guaranteed income for investors, tax-deferred growth, and other advantages, but you carefully need to consider which type of pension annuity you will get.
Disadvantages of Annuity
The main issue that individuals can face with annuities is that they are very complex, so it may seem daunting to choose the right type without a certified financial planner or an independent agent who can find the best offers.
That’s where Insurance Geek comes in. We can offer consulting services and find you the rates from over 30 insurance companies.
Types of Annuity
There are 4 main types of annuity scheme you can opt for:
- Fixed Annuities. A fixed annuity is a low-risk option because it has a guaranteed interest rate on the contributions. It is a deferred annuity, meaning that no taxes are due until retirement, i.e., the time of withdrawal.
- Multi-Year Guaranteed Annuities (MYGA). An MYGA is actually a type of fixed annuity, but it differs in that it has a guaranteed income interest rate for a stated number of years (e.g., 3, 5, or 7 years). At the end of this period, you can choose to withdraw the funds, re-invest, or start receiving income.
- Single-Premium Immediate Annuity (SPIA). Single-Premium Immediate Annuity is another type of fixed annuity, which is funded with the lump sum option and then pays out income based on the pre-established terms.
- Variable annuities. A variable annuity is dependent on the investments and performance, so it comes with a higher risk, but it can also generate a higher return than the other types. Additional fees are usually charged for this type of annuities.
- Fixed Indexed Annuities. A fixed indexed annuity is a hybrid model in which the rate of return is based on the performance of a stock market index. However, even when the performance is negative, the annuity doesn’t lose value because it’s backed by a guaranteed minimum “floor” (usually between 0 and 2%). This option also allows for a life income stream.
Pension vs Annuity: Main Differences
Type of Product
An annuity is an insurance product that you can obtain from an insurance company, while a pension is a retirement plan, and it cannot be bought if your employer doesn’t offer it.
An individual is in control of their own annuity amount and retirement savings, whereas the pension amount is dictated by the employer, and not always transparent.
Receiving Payout: Lump-Sum Payment vs. Monthly Payments
Both options provide income in retirement, but unlike pensions, an individual can use the benefits of an annuity even before they retire. The insured person decides upon the terms of an annuity, like the guaranteed lifetime income model or an immediate payout, less or more risk on the investment, etc.
Also, a person receives an annuity in a lump sum payment or regular payments, whereas pension usually is usually cashed out in monthly payments. An annuity also can be bought in a lump sum. A lump-sum pension is rare.
A traditional pension is set up by your employer, so you don’t have to do that much research. In that sense, it’s easier to understand a pension plan than an annuity, which is an insurance product.
That said, we’re here to help you understand any insurance lingo terms you may come across. Understanding an annuity doesn’t have to be less approachable than understanding a pension – and you’re on the right track by reading this article.
Find the Best Annuity Rates Online
With all the information taken into account, it can be difficult to find the right annuity for you. There are many different types you can purchase to secure your retirement – not to mention that the quality of services varies with different insurance companies.
We wanted to make the matter less complicated for you, so we’ve created an annuity rate calculator. It generates instant annuity quotes from over 30 insurance providers who are our carriers, with great options and choices.
Here’s how it works: You only need to provide us with some basic info about you – it won’t take you longer than 60 seconds to fill in the data – and we will find you the quotes you can compare and find the best deal for you. The whole process is free, and we only use your info to obtain the annuity rates.
Our agents work like financial advisors in the sense that we go out there and find you the best options, rather than trying to sell you one option from a single carrier.
Also, an insurance agent – Insurance Geek – can assist you with any additional options you may have.
Final Words: A Reliable Retirement Income
We hope this guide helped you made the pension vs. annuity decision.
If your employer doesn’t offer a pension, or you decide to go with a pension annuity to ensure that you have a guaranteed lifetime income, Insurance Geek can help you find the insurance company and calculate your annuity rates.
Feel free to contact us today. We look forward to hearing from you!