Pensions: Guaranteed Income You Can't Outlive

What a pension actually is. A defined-benefit pension flips the logic of a 401(k). A 401(k) is a defined-contribution plan: you (and maybe your employer) put money in, you choose investments, and whatever the balance grows to is what you have — you carry the market and longevity risk. A defined-benefit plan promises a specific monthly benefit instead, and the employer is on the hook to fund and invest a pool to pay it, no matter how markets behave or how long you live. That risk transfer is the whole point: a pension is a paycheck that doesn't stop until you (and often your spouse) do.

How the benefit is set. Pensions use a formula, not an account balance. A typical one is a multiplier × years of service × final average salary. If the multiplier is 1.5%, you worked 30 years, and your final average salary was $90,000, your annual pension is 1.5% × 30 × $90,000 = $40,500 a year ($3,375/month) for life. Multipliers commonly run 1%–2.5%; "final average salary" is usually the average of your highest three or five years. Because longevity and career length drive the number, pensions reward long tenure — and the last few years of raises can meaningfully lift the base.

The payout election — the decision that outlives you. When a pension starts, you choose how it pays:

- Single-life annuity: the highest monthly amount, but payments stop entirely at your death. Best only if you're single, or your spouse has ample income of their own.
- Joint-and-survivor annuity: a reduced monthly amount (often 5–15% lower) that continues paying your surviving spouse a set share — commonly 50%, 75%, or 100% — for the rest of their life. The higher the survivor percentage, the lower the starting check.

Because a single-life election can leave a surviving spouse with nothing, federal law (the Retirement Equity Act, layered on ERISA) makes a qualified joint-and-survivor annuity the automatic default for a married participant. To choose single-life instead, your spouse must sign a notarized waiver — a deliberate guardrail against one spouse quietly signing away the other's security.

Lump sum vs. lifetime income. A growing number of private plans offer to cash you out with a one-time lump sum instead of monthly checks. This is a genuine fork:

- Taking the annuity gives you guaranteed, longevity-proof income with zero investment work — and it's the strongest possible defense against sequence-of-returns risk (Chapter 8) and outliving your money (Chapter 23). The costs: little flexibility, usually nothing left to heirs, and — for most private pensions — no inflation adjustment, so 2–3% inflation quietly erodes the check's buying power over a long retirement. (Most federal and many state/local pensions do include a COLA, which is a large hidden advantage.)
- Taking the lump sum hands you control, the chance for market growth, and something to leave heirs — but transfers all the market and longevity risk back to you, and demands the discipline not to overspend. It can make sense if you're in poor health, already have plenty of other guaranteed income (Social Security plus a spouse's pension), or worry about a shaky plan sponsor.

The rollover mechanics that protect the lump sum. If you take a lump sum, how you take it decides the tax bill. A direct (trustee-to-trustee) rollover to a traditional IRA moves the money without any tax — it stays tax-deferred until you withdraw it later, and you keep control of investments. If instead the plan cuts you a check, it must withhold 20% for federal tax, the entire amount becomes taxable income that year (potentially a six-figure spike into top brackets, plus a possible 10% penalty if you're under 59½), and you'd have to replace the withheld 20% from other cash to roll the full amount within 60 days. The rule of thumb: never touch a pension lump sum directly — always roll it trustee-to-trustee unless you have a specific reason to realize the income.

How pensions are taxed. Monthly pension payments are ordinary income, taxed at your regular rates and reported on a 1099-R — exactly like a traditional-IRA or 401(k) withdrawal, because the money was contributed and grew pre-tax. Two wrinkles: if you made after-tax contributions to the plan (common in older and some government pensions), a portion of each check is a tax-free return of that basis, calculated with the IRS Simplified Method. And because pension income is ordinary income, it lifts your provisional income (making more of your Social Security taxable — the "tax torpedo," Chapter 11) and your MAGI for IRMAA (Chapter 12). A guaranteed pension is wonderful, but it fills your lower brackets first, leaving less room for cheap Roth conversions (Chapter 13).

The PBGC backstop — and its limits. If a private single-employer plan fails, the federal Pension Benefit Guaranty Corporation (PBGC) steps in and pays benefits up to a legal maximum. For a plan terminating in 2026, that cap is about $7,789.77/month ($93,477/year) for a straight-life annuity starting at 65 — lower if you retire younger or elect a survivor option (roughly $7,010.79/month for a joint-and-50% survivor benefit). Most retirees' benefits fall under the cap and are fully protected; very high earners with large promised pensions can lose the excess. Note the gaps: government pensions are not PBGC-insured (they rely on the taxpayer and the plan's own funding), and multiemployer (union) plans fall under a separate, much lower PBGC guarantee.