Planning for retirement can be confusing. You can rely on employer-sponsored plans, Social Security or your own retirement account. To ensure a comfortable retirement, you may want to use multiple avenues for your retirement savings. An annuity provides you with tax-deferred savings as well as a guaranteed income. A pension fund will pay out a pension, which can be taken as a lump sum or as a monthly payment.
TL;DR (Too Long; Didn't Read)
A retirement annuity acts as an insurance policy you can buy, while a pension fund is a pool of money put together by employees and their employer.
Understanding How Annuities Work
Annuities allow you to set aside funds for later use. They are issued by insurance companies. You may receive interest on the funds you invest. Your funds may also be invested in mutual funds, stocks or bonds. Some annuities pay interest based on an index, such as the Standard & Poor’s 500 index. You can buy an annuity with a lump sum or make periodic payments over time.
When you’re ready to retire, you can begin taking an income from your annuity. This is called annuitization. You can opt to receive monthly or annual payments for life. If you die before taking an income, your annuity goes to a beneficiary.
Exploring Pension Funds
A pension fund is a pool of money contributed by employees and their employer. This money is invested and paid out to retirees. This payment is called a pension. Your pension payments may be based on your salary when you retire or on the contributions you and your employer made to the plan. When you retire, you may have the option to take a lump sum payment or a monthly income. Many government workers have a pension, while private sector employees are more likely to have a 401(k) or other voluntary retirement plan.
Identifying Similarities and Differences
The biggest difference between annuities and pension funds is control. Annuities are voluntary retirement vehicles. You purchase the annuity yourself after reviewing your options. Participating in a pension fund is required by employers who offer a pension. You don’t have control over how the funds are invested.
Another difference is in how they are protected. Annuities are guaranteed up to a maximum by the state in which the insurance company is doing business. Guarantees vary from state to state. Pensions are guaranteed by either the state of the pension fund or by the Pension Benefit Guaranty Corporation.
Both annuities and pension funds can provide you with a guaranteed income for life. They both have tax advantages, although those advantages are different. Contributions to a pension fund are taken pre-tax, which lowers your income tax. Annuities are tax-deferred, which means you don’t pay taxes on your earnings until you start taking an income. Annuities are purchased with after-tax income.
Melinda Hill Sineriz is a freelance writer with over a decade of experience. Her work has appeared on Pocket Sense and Sapling. She specializes in business, personal finance, and career writing. She has worked in insurance sales and financial planning, helping families to manage their money and prepare for the future. Learn more about her and her work at thatmelinda.com.