Although defined benefit plans (aside from their “defined contribution plan in disguise” cousin the cash balance plan) are becoming less frequent all the time, there are few high income professionals who will still be getting one. At the time of retirement, the retiree may be offered multiple options, and it would be wise to consider the merits of each of them.
Lump Sum Vs Annuity
Many plans will offer you an option to simply take a lump sum rather than the lifetime annuity option. Retirees are often confused about which one they should take. The truth is that it depends, but it is a relatively easy choice to make. First, determine the terms of the annuity option. If the annuity is fixed (i.e. pays you the same exactly amount every month for the rest of your life) you can simply compare the payout of the annuity, with the payout you could obtain from a Single Premium Immediate Annuity (SPIA) bought with the lump sum you are offered in exchange. If the annuity is paying $3200 a month, and you could use the lump sum to buy an annuity paying $3400 a month, then take the lump sum.
If the annuity has some sort of inflation protection, it becomes a bit more complicated. You may be able to find a SPIA with a similar inflation-tracking component, and still do an apples-to-apples comparison, but if not, there may be a little guesswork involved-i.e. if inflation is high one option is better, if low, the other would be better.
Also, keep in mind if you are in terrible health or have dangerous hobbies, you may get a much higher annuity rate from a certain company than your employer will give you. Of course, if your health is so bad that you are unlikely to make it to your life expectancy, perhaps you ought to just take the lump sum and avoid annuitizing anything! If you already have more guaranteed income than you need or want, such as a pension from your spouse's employer + Social Security +/- previously purchased SPIAs, you may also just want that lump sum.
You might also be able to take part of your pension as a lump sum, and part as annuity. Even if your employer doesn't offer that option, you can certainly just take the lump sum and only use part of it to buy a SPIA.
Single Life + Life Insurance vs Joint Life
Another option offered to many retirees is to buy an annuity just on their life (which pays more, but only until the worker dies) or to buy one that pays 100% of the benefit until the worker or the spouse dies. Depending on the age and health of the two spouses, that may or may not be a good deal. The best way to tell is to price a permanent life insurance policy that, when combined with the Single Life Annuity, would provide for the uncovered spouse in the event of the spouse's death. That doesn't have to be a whole life policy, a cheaper guaranteed universal life policy is probably a better option most of the time.
There are lots of other options too…sometimes the benefit is decreased by 25-50% when the first spouse dies in exchange for a higher payout. All those moving parts make it a bit harder, but certainly not impossible to compare apples to apples. Your spouse probably won't need the exact same amount you both needed while you were living, but he will probably need more than 50% of it.
Have you (or a family member) been faced with a pension lump sum vs annuity decision? How did you decide? Was it the right decision in retrospect? Comment below!