When you approach retirement, if you’re fortunate enough to have worked in a job that provides a pension plan, you are faced with a decision: what type of payout should you choose? There are generally several – the first choice is between a lump sum versus an annuitized payout.
The lump sum works just like it sounds – you get the equivalent of your account in the pension system in one big lump – and you can rollover this lump sum into an IRA or other tax-deferred vehicle, taking distributions as you see fit over your lifetime. At some point (age 72 for most cases) you’ll be required to take distributions from your account.
On the other hand, an annuitized payout is where the money comes to you in a (generally) set amount over your lifetime, rather than all at once. And with the annuitized option you often have several choices to consider – such as an annuity based solely on your life, or one based on your life and the life of a potential survivor of yours, most often your spouse.
There’s also often an option to receive the pension payments over a specified period of time, regardless of whether you live that long or not. These options are generally either 10-year payments or 20-year payments. With this plan you (and your survivor if you don’t live that long) will receive payments for either 10 or 20 years in a set amount, after which the payments cease.
Another, less common, type of pension payment option is known as the level payment option, which is the topic of this post.
Level payment pension plan option
With most of the annuity payment options, once your benefit payment amount is determined, unless there is an inflation adjustment factor built in, your payment remains the same during your lifetime. For the survivor options, the payment might change after you pass away – such as with the joint-and-50% survivor option, where you receive one payment amount during your lifetime, and your surviving beneficiary receives 50% of that amount once you die.
With the level payment pension plan, the idea is to incorporate your pension payment along with your Social Security payment. The way it works, if you’ve retired and wish to begin receiving the pension at some point before you start receiving Social Security benefits, a level payment plan will provide you with approximately the same month-to-month income for the entire period of time, including before and after you’ve started receiving Social Security benefits.
In practice, an estimate is made of the amount of Social Security benefits that you’ll be eligible to receive at a specified age. Sometimes the age is set at 62 (the earliest age you can start Social Security retirement benefits), or at Full Retirement Age (which could be between ages 66 and 67, depending on you date of birth). Some plans arbitrarily set the age at 65, which is known in the retirement planning world as “normal” retirement age.
(This is a throwback to the olden times when 65 was the Social Security Full Retirement Age, or FRA. FRA hasn’t been 65 for quite a while, but it’s still the triggering age for Medicare. Many plans simply haven’t updated the feature.)
Once you have the estimate of the amount of your Social Security benefit, the pension plan is adjusted to coordinate with it.
For example, let’s say you have a pension plan that would commonly have a single-life annuity monthly payment of $1,000. You’ve gotten an estimate of your Social Security benefit at age 62, and the amount at that age is $750 per month. Your level payment pension plan might provide you with $1,550 per month up to your age 62, and then drop to $800 per month. When you add in the anticipated $750 from Social Security, you maintain the same retirement income level of $1,550 both before and after you’ve filed for Social Security benefits.
Practical application of the level payment option
Of course, like all choices in life, there can be problems to deal with for the level payment option.
For example, what happens if you’re not ready to start receiving Social Security benefits at 62? Once you’ve chosen the level payment option, you can’t change it – so regardless of whether you take your Social Security benefit at the prescribed age, your pension payment will reduce at that time. So you could wind up with a shortfall if you decide to delay starting your Social Security benefit to a later date.
On the other hand, let’s say your level payment plan indicates a Full Retirement Age starting date for your Social Security payment. There’s no requirement for you to wait that long – if you wanted to, you could start receiving Social Security benefits at age 62, with no impact to your pension amount. The reduction to the pension would still occur at FRA as planned, and since you started your Social Security benefit earlier (and therefore it is at a reduced amount), your ending total of pension plus Social Security will be less than was originally calculated.
For example, let’s say you expect a $1,000 Social Security benefit at Full Retirement Age. Your level payment pension (pre-Social Security) is set at $1,550, dropping to $550 after you’ve reached FRA (age 67 for our purposes). You could start your Social Security benefit at 62 instead, at a benefit amount of $700. This would give you a total retirement monthly income of $2,250 (your $1,550 level payment pension plus $700 in Social Security benefits) up to your age 67, FRA. At FRA, your level payment pension plan drops to $550, and so now your total retirement monthly income is down to $1,250.
That seems pretty harsh, but if you crunch the numbers, you’ll realize that you’ve received $700 a month for five years (60 months), for a total of $42,000 (no COLAs are included in this calculation to reduce complexity). So if you had saved the extra, you could use that $42,000 to augment your other monthly income, making up the $300 reduction for a long time to come. ($300 is the difference between your original level payment and your post-leveling payment after you’ve reached FRA. This assumes that you “banked” the $700 Social Security benefit payment during the intervening 5 years.)
Considerations with the level payment option
No matter what you decide to do about the timing of your Social Security benefit, if you’re considering the level payment option you need to run the numbers against all of your other choices to help you figure out what’s the best way to go.
Keep in mind that the level payment option is front-loaded, giving you more pension benefits early in your life, and far less later. There also is no survivor component built in to the level payment option. Your surviving spouse will have to get by on Social Security benefits alone, along with your other retirement savings, and forego the pension after your death.
Not many folks choose the level payment plan from my experience, in part because it’s complicated and sort of locks you into choices early on in your retirement. But for some, this is exactly what is needed to bridge the gap between an early(ish) retirement and the start of Social Security benefits.
Consult your favorite advisor to help you best understand your options and what might work best for you.