Annuity vs. Pension

Both annuities and pensions provide regular payments, but they also offer unique features. It is important to understand the differences to ensure a steady income stream during retirement. In this article, we will give you key takeaway points in the topic of an annuity vs. pension so you can make an informed decision.

What is a Pension

A pension is a benefit from an employer. They will provide you with regular payments once you retire. Typically, you must work for an employer for a minimum number of years to receive these benefits. Your benefits will be paid out based on a few factors like age, health, experience, and company resources.

There are two types of pensions: defined benefit plans and defined contribution plans. Defined benefit plans will guarantee the employee a specific monthly benefit when they retire. This amount is calculated by salary, age, and how many years the employee worked for the company. The employee does not have a say in how funds are invested nor can they take control of a lump sum. However, they are provided with guaranteed lifetime income. On the other hand, with a defined contribution plan both the employer and the employee contribute to the fund. The benefit amount is not guaranteed and can vary depending on how the pension’s investments perform overtime.

What is an Annuity

An annuity is a contract between a customer and an insurance company. In exchange for a lump sum payment the insurer agrees to provide the customer with an income. There are a few types of annuities. First, is a fixed annuity, which pays a guaranteed interest rate and provides a stable income. Second, is a variable annuity. With this type of annuity your gains depend on the performance of an investment account. No returns are guaranteed. Lastly, is a fixed indexed annuity. With this type of annuity earnings are linked to the performance of a market index. Usually, there are limits on gains and some protection against losses.

Comparing an Annuity vs. Pension

Annuities and pensions have many differences and a few similarities. They fall under several different categories. First, is how they are funded. Pensions are funded with employer and potentially employee contributions. Annuities are funded with personal savings or a retirement account rollover. Second, is who bears the investment risk. With a pension the employer takes the risk if it is a defined benefit plan and the employee shoulders the risk if it is a defined contribution plan. Whereas, with an annuity the insurer bears the risk if it is a fixed annuity and the annuitant bears the risk if it is a variable annuity.

Next is availability. Pensions have very limited availability. You must work for a company or agency that offers one. On the other hand, anyone with sufficient savings can utilize an annuity. Fifth, is the portability. A pension is tied to an employer typically. Benefits are not portable. An annuity, however, if fully portable. Sixth, is guaranteed income. Both a pension and an annuity offer guaranteed income. Seventh, is government protection. With a pension the PBGC guarantees up to $7,542.63 a month at age 65. And for an annuity state guaranty associations protect up to $250,000.

Eighth, is how they are taxed. Both have deferred taxation and are taxes as ordinary income. Then we have survivor benefits. Pensions may have an optional joint and survivor election. An annuity will have an optional rider to ensure joint life payout. Lastly, is the cost to you. A pension comes with no cost whereas an annuity has premiums and fees, depending on the product.

Choosing an Annuity vs. Pension

When it comes to choosing an annuity vs pension, you do not have to choose one over the other. They can both work for you and a successful retirement plan.

Questions? Want to schedule an appointment? Contact us by clicking here.