Pension Payout Elections: Lump Sum, Single Life or Survivor

Why this decision is different

Most retirement decisions can be adjusted later. A withdrawal rate can change, an allocation can be rebalanced, a Social Security claim can sometimes be withdrawn within the first year. The pension payout election is usually different: it generally becomes irrevocable after a plan-specific deadline.

Certain plans permit limited changes after retirement because of death, divorce, remarriage or specific plan provisions, so the exceptions are worth asking about rather than assuming. CalPERS, as one example, states that the retirement option, beneficiary and retirement date generally become irrevocable 30 days after the first retirement payment is issued. CalSTRS and private plans have their own rules and deadlines. Whatever the plan, the date is worth treating as a hard stop, with the analysis finished before it rather than after.

The common payout options

Plans name their options differently, but most fall into a few families.

A general summary. Not every plan offers every option, and terms differ. Your plan's own election materials control.

Private and public plans

Private employer plans. For married participants, most private defined benefit plans must pay a qualified joint and survivor annuity by default, with at least half continuing to the surviving spouse. Choosing a single-life payment or a lump sum generally requires the spouse's written consent, witnessed by a notary or plan representative. Benefits in most private single-employer plans are insured by the Pension Benefit Guaranty Corporation, subject to eligibility requirements and benefit limits.

Public plans. Governmental plans such as CalPERS and CalSTRS follow their own statutes rather than the private-plan spousal consent rules, and they are not insured by the Pension Benefit Guaranty Corporation. Their options, the effect of community property on the election, and the deadlines are set out in each system's retirement materials. Because the option names and survivor percentages differ by system and membership category, the plan's own estimate for each option is the starting point for any comparison.

Lump sum or monthly income

Where a lump sum is offered, the comparison is not simply the size of the check. A monthly pension generally provides predictable income and reduces the retiree's exposure to longevity and investment risk, subject to the plan's financial condition and applicable benefit protections. However, pensions without cost-of-living adjustments remain exposed to inflation risk. A lump sum transfers responsibility for investment management, withdrawals and longevity planning to the retiree.

• Interest rates. Private-plan lump sums are generally calculated with interest rates set under federal rules. Higher rates generally produce a smaller lump sum for the same monthly benefit.
• Longevity. A monthly payment continues however long the retiree, or a covered survivor, lives. A lump sum lasts as long as it is managed to.
• Inflation. Some public pensions include cost-of-living adjustments; many private pensions do not. Where there is no adjustment, purchasing-power risk stays with the retiree, which changes the comparison considerably over twenty or thirty years.
• Taxes. An eligible pension lump-sum distribution rolled directly into a traditional IRA generally remains tax-deferred. A rollover into a Roth IRA may create current income tax on the taxable amount. If the distribution is paid directly to the participant, mandatory federal withholding generally applies to the taxable eligible rollover amount, and additional taxes may apply depending on age and circumstances, as covered in early withdrawal penalties in California.
• Sequence of returns. A lump sum invested at retirement is exposed to a poor early market in the way described in sequence of returns risk.

What the survivor actually receives

The survivor comparison is the one most often under-modeled, because the effects arrive years later and in several places at once.

The surviving spouse's pension income changes by the survivor percentage chosen. Social Security changes too: the survivor generally keeps the larger of the two benefits, not both, as covered in Social Security claiming decisions. The death of a spouse may also change the surviving spouse's tax filing status and applicable tax brackets. Depending on the circumstances, a surviving spouse may qualify for a different filing status for a limited period. These changes should be considered when modeling future retirement income and taxes.

Health coverage can depend on the election as well. In some public plans, a surviving spouse's eligibility to continue retiree health coverage is tied to receiving a monthly survivor benefit. Choosing an option with no survivor benefit can end that coverage at the retiree's death. Confirm how your own plan treats it before electing.

Life insurance instead of a survivor option

One approach sometimes discussed is to take the higher single-life payment and buy life insurance intended to replace the survivor income. Using life insurance instead of a pension survivor option is not appropriate for every household. Insurance premiums, underwriting, policy duration, exclusions, possible lapse, investment assumptions and the financial needs of the surviving spouse should all be evaluated. The comparison should also consider whether the survivor pension provides benefits that life insurance cannot replace, including certain retiree health coverage rights.

In practical terms that means the policy has to be underwritten and in force before the election is made, premiums must be paid for life, and the death benefit has to be sized and invested to produce the income it replaces. If the policy lapses, the survivor protection is gone and the election generally cannot be reversed.

Any such comparison should be modeled on the actual plan figures and actual policy terms. Insurance products are offered through our affiliate, Lucas Insurance Services, which may receive commissions from issuing insurance companies. This creates a conflict of interest in any recommendation involving insurance, and it is disclosed in our Form ADV. Guarantees are subject to the claims-paying ability of the issuing carrier.

How Avinci approaches it

Avinci Wealth Management is a Registered Investment Adviser registered in California, Arizona, Illinois, Texas, and Nevada, firm CRD #327780, headquartered at 23929 Valencia Blvd, Suite 404 in Santa Clarita, with additional offices in Beverly Hills and Woodland Hills. When providing investment advisory services, Avinci Wealth Management is subject to its fiduciary obligations under applicable investment adviser law.

West Hills residents are a short drive from Avinci's Woodland Hills office, where clients meet with Lindahl Lucas to build their Retirement Blueprint. Avinci serves as financial advisor and financial planner for San Fernando Valley households, coordinating investment management and tax planning with insurance and annuity planning, which is offered separately through our affiliated agency, Lucas Insurance Services.

Through the Retirement Blueprint planning process, available pension payout options may be evaluated alongside Social Security timing, retirement withdrawals, potential taxes and survivor income needs. The scope of the analysis depends on the client's circumstances and the information available from the pension plan. Founder Lindahl Lucas is involved in overseeing the development of Retirement Blueprint planning. Tax scenarios are modeled in coordination with your CPA, who prepares the returns.

Avinci receives advisory fees for investment advisory services. Separately, insurance and annuity products may be offered through our affiliated insurance agency, Lucas Insurance Services, which may receive commissions from issuing insurance companies. This compensation arrangement creates a conflict of interest and is disclosed in our Form ADV.