Annuities are insurance policies that function as long-term retirement savings vehicles and may also guarantee you an income at retirement, depending on the type of annuity. Annuities are generally purchased and funded by individuals. Pensions are retirement plans, but they also guarantee payments. Pensions are established by employers or unions and are funded by the employer instead of the individual. You should understand the differences between the two before you retire so that you can make the best retirement income decisions.
A deferred annuity helps you save by accepting contributions to the annuity contract. Those contributions are then invested into a variety of different investments, depending on the contract. The annuity returns may be guaranteed or non-guaranteed. An immediate annuity converts your savings into monthly payments, which are guaranteed for your life or for a set number of years.
A pension often uses annuities to guarantee the payments promised to employees. The pension might even consist of a single annuity, called a group annuity, that pools money for all employees. When employees retire, the pension converts part of the annuity associated with the employee to a guaranteed monthly payment.
You may choose to take pension payments or you may take the money as a lump sum from your pension and convert it to an annuity yourself. With a lump sum pension payment, you get to choose how your pension money is invested. You may convert some or all of the pension to guaranteed payments. Or you may not convert any of it.
If you decide to take a lump-sum amount from your pension plan, be sure you understand and are comfortable with investing. You should be able to replicate the results of the pension somewhat, though pensions often offer sophisticated payment plans that are difficult to replicate fully. For example, a pension plan may offer you a reduced pension payment in exchange for beneficiary payments to your spouse if you predecease her. You would have to know advanced income planning strategies if you were to attempt this yourself outside of the pension plan.
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007
- IRS: Publication 575
- "Life Insurance"; Kenneth Black, Jr., Harold D. Skipper, Jr.; 1994
I am a Registered Financial Consultant with 6 years experience in the financial services industry. I am trained in the financial planning process, with an emphasis in life insurance and annuity contracts. I have written for Demand Studios since 2009.