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Annuity vs. pension: Two different ways to secure income for life

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There's nothing like income for life to give you the sense of reassurance you need to thoroughly enjoy your golden years. But for most, other than government workers, the employer-sponsored pensions that used to provide that benefit are largely a thing of the past. In their absence, you might look to annuities to provide an income stream you can't outlive.

However, an annuity vs. pension isn't a direct comparison. That's why it's important to understand the differences when weighing the role each might play in your financial plans and future goals. If you're looking ahead to retirement and curious to learn more about each of these options, here are the key details to know.

What is a pension?

A pension—or more precisely, a defined benefit (DB) plan—is an employer-sponsored retirement plan that pays employees income for life upon their retirement. The payment is typically calculated based on age, years of service and salary, according to a set formula.

If you have a DB plan the employer makes contributions to the plan on your behalf. You don't have to worry about where the money is coming from, how it's invested and who's managing it. You simply receive the amount, usually monthly, for the rest of your life. These funds can be used however you choose, whether to pay for routine costs of living, provide financial support for loved ones or donate to favorite charities.

If your former employer is unable to meet its pension plan obligations, the Pension Benefit Guaranty Corporation (PBGC) steps in. A government agency that insures private-sector DB plans, the PBGC may not replace 100% of benefits, but it offers an extra layer of protection.

Defined benefit plans have become less common

Many retirees see this set-it-and-forget model as ideal. You might, too. You'd probably much rather travel, golf or play with the grandchildren than determine how to pay this month's electric bill.

Most DB plans offer several options for configuring payouts. These can include a life income for you, a joint life income for you and your spouse, as well as reduction factors such as a 50% payout to your spouse after you pass away.

Traditional DB plans can represent a tremendous benefit. But most employers have switched to defined contribution (DC) plans such as the 401(k). Unlike DB plans, most DC plans are employee funded and managed. Employers sometimes contribute on the employee's behalf, such as a 401k match, but they make no promises about the benefits the plan provides come retirement. Rather, that depends on how much you contributed and the underlying investments' performance.

If you opt for a more aggressive portfolio, you may have the potential to reap greater rewards than even DB plans, but you also assume the risk of doing so. DC plans offer other advantages—such as the opportunity to tap retirement savings for specific needs during working years—but most lack the income-for-life payout option. Fortunately, you have another way to create income you can't outlive.

What is an annuity?

An annuity is an insurance product that permits its owner to convert existing savings to a periodic income stream. There are a few types of annuities that differ in how they're funded, invested and paid out. Immediate annuities are one of the most popular options, as their primary benefit is the income-for-life feature that those without DB plans may seek. In addition, deferred annuities may accumulate for many years before an income stream is started.

Here's how it works: You pay a financial institution a lump sum or multiple sums of money. The company agrees, per a contract, to pay a future income stream you can't outlive. From there, it's up to the institution to determine how to manage the money so it can deliver on this promise. For some annuities, the payments may be the only way to recoup the original investment's value. Other annuities allow for additional withdrawals but your future payments will be reduced.

Annuities can act as a self-funded "pension" if you aren't eligible for a traditional DB plan.

What are the differences between an annuity and a pension?

For all the similarities between annuities and pensions, you should be aware of a few differences when crafting a retirement income plan.

The other party involved

For starters, the other party in an annuity contract is a private insurer instead of a former employer. It's only as good as the insurers ability to manage its financial obligations over the long haul.

The complexity of each account

Complexity is also a consideration. Electing to receive a pension is straightforward since the arrangement is largely predefined. With an annuity, however, you have many companies, products and features to choose from. Each comes with its own set of costs. It's up to you to explore, compare and choose well from this wide range of alternatives. A financial advisor can help here, as they can provide personalized guidance based on your individual needs and unique financial situation.

The flexibility each account offers

Annuities may offer greater flexibility in terms of funding and payout options. This can allow you to create custom solutions that better fit your needs than a largely one-size-fits-all employer pension might.

Whereas pension income is based on employer contributions to the plan, you can fund an annuity with money from many different accounts. That includes savings, brokerage accounts, individual retirement sources, DC plan. This ability to use pre- or after-tax money opens up retirement income strategies not available to traditional pensioners.

Say you're anticipating varying expenses, income from outside sources and tax rates over the course of retirement. Here, a mix-and-match approach involving multiple annuities of differing amounts, start dates, terms and tax implications could provide flexible retirement income options.

Can you have an annuity and a pension?

If you're a DB plan participant, the annuity vs. pension decision doesn't need to be an either/or proposition—you can have both. Actually, it's possible to have several of each. A multipronged strategy could be an advantageous way to balance the pros and cons of the two options.

Ultimately, the good news is that you have more methods for creating income for life than ever before.

These decisions only make sense in the context of your overall financial picture, which is subject to change over time. That's why it's smart to connect with a financial advisor near you to set up a forward-thinking retirement plan that factors in your needs and preferences.

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Thrivent and its financial advisors and professionals do not provide legal, accounting or tax advice. Consult your attorney or tax professional.

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4.11.22