Carefully choosing when to take your pension can significantly reduce your risk of running out of money. An analysis of when to start your pension income can be quite similar to analyzing when to start your Social Security benefits. Both pensions and Social Security offer guaranteed income for life. Pensions usually offer a choice that allows for continued income for a spouse, and Social Security offers survivor income as well.
That's where the similarities end. Social Security rules are the same for everyone, but each company's pension rules are not the same. This means two upcoming retirees with identical financial and family situations may make very different choices about when to start their pension based on which company they work for.
- Each pension has its own formula that determines how much you'll get at different ages.
- The longer you wait to collect, the better off you are likely to be.
- Factor in taxes from all of your retirement investments before making your decision.
Example of Pension Analysis
David is retiring at 60. His pension offers several options and different payout amounts, depending on what age he chooses to begin his pension income. Although he will retire at 60, it may be beneficial to wait until 65 to start receiving pension income. He has savings and other retirement accounts to provide retirement income from ages 60 to 65 if he decides to delay. Here is a summary of two of David's pension choices:
- Age 60: $19,536 per year
- Age 65: $34,128 per year
Should he start his pension at age 60 or 65?
If David waits five years to start his pension, he will get $14,592 more per year, but he will miss out on $97,680 (5 years x $19,536 per year). To do a simple analysis, divide $97,680 by $14,592. He recovers the $97,680 in 6.7 years, in the year he reaches age 71, which could be referred to as his "break-even age."
A simple analysis, however, doesn't take into account the time value of money. If David has to use $97,680 of his own money from age 60 to 65, he will not earn interest on that money. If we assume that David could earn 4% on his money, it moves the break-even age out to about age 73.
Assuming David waits until age 65 to begin his pension, if he lives to 80, his delayed pension start date will put over $120,000 extra in his pocket when compared to starting his pension at 60, assuming a 4% return on David's personal savings and investments.
The higher the rate of return that David thinks he can earn on his investments, the less beneficial delaying the start date of his pension becomes. For example, if David thought he could earn a 10% rate of return on his savings and investments, his break-even age would move out to age 82.
Be cautious in assuming you can earn a high rate of return, as you must also consider the level of investment risk required to attempt to earn that higher return. Pension income is guaranteed. Comparing pension benefits to riskier investments is not a fair analysis. It's often difficult, if not impossible, to find a higher rate of return on safe investments.
If David were married, a similar break-even analysis could be done using pension options that provide ongoing income to a surviving spouse. In that case, joint life expectancy should be considered.
A financial planner can help you determine whether it's beneficial to start your pension early.
Every Pension is Different
Each pension has its own formula that determines how much you may get at what age. If you have multiple pensions, it may be best to start one at age 60 and one at 65.
Taxes should also be considered in your final analysis. Sometimes delaying the start date of your pension and taking IRA or 401(k) withdrawals during the interim years provides an improved tax outcome when viewed over your full retirement time horizon.
Your gut feeling on when to begin pension benefits might not be right. Careful analysis in this area can pay off. Don't begin pension benefits without first looking at the numbers projected out over your full number of expected years in retirement.