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Selecting Retirement Payout Methods

One big change that retirement brings is you begin to take income from your defined benefit pension or defined contribution plan. You have to consider various payout methods, or the ways in which the income will come to you.

The right alternative for you, or you and your spouse if you’re married, depends on a variety of factors such as your other sources of income, your comfort level with investment risk and even your health.


When you retire from an organization that offers a pension, you generally have at least two options. You can:

  • take a pension annuity and receiving a monthly check; or, if your employer allows,
  • take a lump-sum distribution, which you will need to invest and manage: lump sums can be rolled into an IRA, where you are taxed only on money you decide to take out.

Annuity Payments

An annuity, or stream payout, is the traditional way to receive income from a defined benefit pension plan. With this option, you get a check each month for the rest of your life or another fixed period. Your employer calculates the amount based on a number of factors including your age at retirement, your salary and the number of years you have worked. You know before you retire how much income you will receive.

With an annuity, you will not worry about outliving your pension payments. Because you know that the same amount is coming in on a regular basis, budgeting for both your everyday and unusual expenses may be easier.

You need to understand, however, that inflation can erode the purchasing power of most annuity payments over time. Carefully evaluate the current and long-term financial condition of the entity that pays the annuity. Often it is an insurance company. One way to do so is checking the credit rating of the annuity provider.

If you decide to take a pension annuity, you then must decide how you want the pension to be paid. Your options include the following:

  • Single-life Option. You might choose a payout that lasts for your lifetime only, called a single-life or straight life annuity. With a single-life annuity, when you die, the payments stop—even if you die soon after they start. To protect against that possibility, you might consider a single-life with a period-certain payout. This method provides income to the beneficiary you name for a specified period, such as ten or twenty years, if you die before that period ends. This option, however, results in a lower payment.
  • Joint-and-survivor Option. Alternately, you could choose an annuity to be paid out over your lifetime plus the lifetime of another person, usually your spouse, in what's called a joint-and-survivor payout. The amount of your monthly check is less than what you'd receive with a single-life annuity, with or without a period certain. But after you die, your survivor will get the percentage of your pension you specified up front every month for life. Depending on your distribution options, you may be able to select between 50 and 100 percent of the payment for the survivor.
  • Period-Certain Option. There's also the option of a period-certain payout with a joint-and-survivor annuity. This option provides income to a beneficiary you name for a specific period if both you and your spouse die before the period ends.

Smart Tip: Your Spouse May Have Rights Too
Some companies require married employees to select a joint annuity payout option or have the spouse sign a waiver if an individual annuity is selected.

Lump-Sum Payment

A lump-sum distribution of your pension may be another option when you're ready to decide on a defined benefit payout. In this case, your employer will either make a cash payment or transfer the amount to an IRA. Your employer calculates the amount you receive based on:

  • what the plan would have paid you as an annuity over your projected life expectancy; and
  • the current interest rate, which determines what the plan would have earned on the lump sum if it had been paid out in increments over your lifetime.

The lump-sum amount will vary with the prevailing interest rates. If interest rates are high, you'll receive a smaller lump sum than you would if rates were low.

Taking a lump sum could be a good choice if your spouse is significantly younger or you want to decide how to invest the money you get. You also have the option of working with a trusted and experienced investment professional. You'll get control over your assets—which could be important if you're concerned that the plan could be underfunded or that your employer could be acquired. A change in the ownership of your employer could result in major changes to the plan and to the pension you might qualify for after the acquisition. If you choose to have your lump sum pension distribution rolled over into an IRA, you can continue to defer taxes until you withdraw money later on.

Here's a quick comparison of annuities and lump-sum withdrawals:

Payout Method Pros Cons
Fixed annuity
  • Regular income on a regular schedule for life
  • No responsibility for making investment decisions
  • Protection against termination of plan or sale of employer
  • Income may be vulnerable to inflation
  • Income dependent on financial health of annuity provider
Lump-sum withdrawal
  • Opportunity to make investment decisions
  • Ability to control assets
  • Continued tax deferral with rollover to IRA
  • Possibility of outpacing inflation
  • Protection against termination of plan or sale of employer
  • Responsibility for providing lifetime income
  • Taxes due immediately on cash-payouts and annual tax on investment earnings
  • Danger of spending assets too fast
  • Danger of significant investment losses

Consider your pension payout options carefully. Once you have made your choice, you usually cannot change your mind.

Smart Tip: Understand the Difference in Getting an Annuity from a Pension Plan and an Insurance Company
The life annuity you get from your company pension is based on the plan formula, which does not usually factor life expectancy or interest rates in the calculation of the payment you get. When you buy an annuity from an insurance company with a lump sum payment, the insurer will factor in your current age, life expectancy, prevailing interest rates and the profit it wants to make to determine the payment you will get. As a result, the annuity payments calculated from the pension plan and the insurance company will be different.

Defined Contribution Plans

When you retire with a defined contribution plan such as a 401(k), you have some options about how to receive income. Your choices generally include taking a lump-sum distribution, keeping your savings in your existing account, annuitizing your assets and rolling them over into an IRA. Your plan administrator will be able to tell you which alternatives are available to you. They usually include:

  • Lump-Sum Distribution. With this option, you take all your money out of your defined contribution plan. While this can seem attractive, keep in mind that a lump-sum distribution is taxable in the year you take the money, unless you roll it over into an IRA. If your lump sum is substantial, it could be enough to bump you into a higher tax bracket than when you were working. While 20 percent of the total will be withheld to cover the federal income taxes that are due, you may still owe an additional amount. What’s more, the money you withdraw is no longer tax deferred, which means that any future interest and dividends will be taxed in the year they are paid.
  • Keep Your Defined Contribution Account. Keeping your savings in your defined contribution account is a second option. This is often the easiest and best choice for many employees, especially if your 401(k) has low expenses and offers adequate investment choices. While it might be the easiest option, it may not be right for you if your 401(k) investment choices are limited, expensive or if your account is heavily invested in your employer's own stock.
  • Annuitize Your Savings. Some employers allow you to annuitize all or a portion of your 401(k) or other defined contribution plan, which means converting all or a portion of the account value into a guaranteed stream of income for the rest of your life. The advantage of this type of annuity is that you cannot outlive your income. The disadvantage is that your payment may be fixed, so it gradually loses purchasing power due to inflation.
  • IRA Rollover. Another choice is to roll over the assets of your 401(k) or other defined contribution plan into an IRA or individual retirement annuity. This way, you can protect your money's tax-deferred status, choose the way the assets are invested, and postpone income taxes until you withdraw. You also avoid the 10 percent early withdrawal penalty you would face if you're younger than 59½. 

Take Stock of Your Company Stock
When you retire, you may want to take a lump-sum withdrawal of company stock from your 401(k) if it has increased in value. You can postpone taxes until you sell, preserving the tax advantages of your retirement account. And any capital gains when you eventually do sell qualify as long-term capital gains. You may want to get professional advice first so you can weigh the potential long-term advantages against possible drawbacks of withdrawing company stock from your 401(k).

Required Minimum Distributions: Get Them Right!
The amount you must take from an IRA or defined contribution plan is called your required minimum distribution, or RMD. You calculate it using a distribution period provided in the Uniform Lifetime table found in Appendix C of Internal Revenue Service (IRS) Publication 590. It's important to get your RMD amount right. If you withdraw too little, you'll face a 50 percent penalty on the amount you should have taken out but didn't—on top of the income tax you'd owe. Use FINRA's RMD calculator to find out what your required withdrawal will be and the rate of return you'll need to earn to maintain your account balance. Also see FINRA's investor alert, Required Minimum Distributions—Common Questions About IRA Accounts.