If you have a pension and can choose between an annuity and lump sum, don't get hung up trying to calculate which option will pay you more over your lifetime. To determine that, you would need to know two unknowable things: how long you'll live and how much your investments, if you go the lump-sum route, will earn. It makes more sense to focus on your pension in the context of your overall financial plan. Start by asking yourself two questions:
• How will I pay my bills after I retire? To determine whether you should annuitize your pension benefits to help pay your recurring bills, draw up an estimate of your postretirement expenses. Also, get an estimate of the Social Security benefits you'll collect by using the Retirement Estimator on its site. Social Security is like a private pension only sweeter because it's indexed for inflation. If Social Security will cover all or most of your bills, you might not need or want another annuity.
If Social Security doesn't come close to covering your expenses, it might make sense to take your pension as an annuity. But think twice if you have little or no additional assets. If you annuitize your pension, you won't have any liquid assets to pay for extraordinary expenses like major home repairs or nursing care.
You can ask your pension plan's administrator if you can annuitize part of your benefit and take the rest in a lump sum, but most plans don't offer that option. Or you can take all of the money in a lump sum, use part of it to buy an immediate income annuity from an insurance company and keep the rest in investments you control.
If you're fortunate enough to have a 401(k) plan as well as a pension, you might take your pension as an annuity and use the money in your 401(k) for emergencies. Most 401(k)s offer only lump-sum payouts, which you can then roll over into an IRA.
• How will my surviving spouse manage? Federal law assumes that your spouse will need to continue receiving monthly checks from your pension after you die. So a joint-and-survivor annuity, which covers your lifetime and the lifetime of your spouse, is the default option on most plans unless your spouse agrees in writing to waive it. It pays less than a single-life annuity because it is expected to pay out for a longer time.
Two-career couples might not need the protection this law offers. For instance, if your spouse also earned a decent pension, each of you might prefer to take single-life annuities. Or you might choose a joint-and-survivor annuity while your spouse takes a lump sum.
Steer clear of so-called pension-maximization plans promoted by insurance agents. In this scheme, you take your pension as a single-life annuity for its higher payout and buy a life-insurance policy. If you die first, your spouse invests the proceeds. The net income you both collect is supposed to be greater than the amount you would have received with a joint-and-survivor pension, even after paying for the insurance policy with after-tax dollars. But such plans can easily fall apart. You might not be able to afford an insurance policy that's large enough. Or you might pay hefty premiums for years, then let it lapse because you can no longer afford it.