Pension Mistakes Can Last a Lifetime: How to Avoid Them

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By Craig J. Ferrantino, Certified Financial Fiduciary®, CWS®

published 22 August 2024

Making an uneducated choice about your pension option can wreak havoc on your financial future, leading you to pay more in taxes than you ever anticipated, miss out on the vacations you always dreamed of in retirement or, even worse, leave your loved ones struggling to afford everyday living expenses after you have passed away.

After many years working, the last thing you would want to do is make a pivotal mistake when selecting a pension option. Below I provide four key factors to consider when making your vital pension decision.

1. Take your time.

The worst move you can make is rushing into a pension option without first evaluating all your choices. Many pension option selections are irreversible once you have committed to them, and even the plans that allow you to make a change give you only a brief window before locking you into that pension option forever. At my firm, we sit with our clients and remind them that they have worked for many years, so we are not going to rush and select an option in just one meeting. This decision process may take many meetings to get it right and ensure everyone is comfortable and confident in the pension option selected.

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Each retiree has a unique future in mind, requiring an intimate understanding of which pension options are best to meet those goals. Factors such as age, medical condition, spousal health and more can dictate the most effective pension option for you. We work diligently with our clients to devise strategies that help decide which pension options best fit their needs, ensuring a smooth transition into retirement. If our clients are married, we insist both spouses are present and involved in this critical decision.

Many married couples need to weigh the difference between joint and pop-up pension options. Some clients come in and ask about taking out life insurance in lieu of adding their spouse to their pension with the survivor option. This strategy is called “pension maximization” and it is one that can be considered; however, I urge you to meet with a trusted financial adviser before going this route.

2. Taxation: It’s not what you earn, it’s what you keep.

Understanding the tax implications of different pension plan options and factoring them into your decision-making process is imperative to making the best possible decision. We are currently experiencing what may be the lowest tax environment of our lives. With the Tax Cuts and Jobs Act set to expire at the end of 2025, there is uncertainty as to whether these low tax rates will continue. This potential change reaffirms the importance of considering taxation when planning your retirement.

Most of our clients who receive pensions have the risk of becoming “tax toxic” later in life. They have a pension, Social Security and then required minimum distributions (RMDs) all coming in at the same time, causing increased taxation. If a distribution plan is not set for how and when these sources of income are going to be tapped, you can be left with very little after-tax money for your living expenses. We always say, It’s not what you earn it’s what you keep!

3. Where are you going to live in retirement?

Some pension plans explicitly offer state tax benefits, which can make a big difference in your retirement income. This makes it critical to research and understand which states provide tax benefits when considering different retirement options.

States tax retirees differently, so your retirement location can significantly impact your future financial security. For example, pensions for state employees like law enforcement officers are exempt from state taxes in New York. Additionally, certain states, such as Pennsylvania, Mississippi, Illinois and Iowa, do not levy state income tax on pensions, Social Security or 401(k) and IRA distributions, making these states desirable for retirees looking to maximize their benefits. And there are nine states with no income tax at all, including Texas, Florida, Tennessee and Nevada. These states provide a more tax-efficient environment, which can be lucrative when attempting to maintain a high retirement income stream.

Deciding to stay put in retirement, choosing to move to a more tax-efficient state, or making another choice is a process that is at the heart of pension planning. Each state imposes its unique taxation regulations, which can have a serious impact on how comfortable your retirement might be.

4. For advanced planning, factor in college costs and your legacy.

One area of pension planning that is easy to overlook is the timing of your children’s education. If you have kids approaching college age, the burden of their education costs can significantly alter your retirement plans. Finding the intersection between your pension option and financial aid opportunities is important in this decision-making process.

Some pension plans offer partial lump sum distributions. This will decrease your pension payment but will give you money to roll into an IRA or other qualified account that can then be invested and grow tax-deferred. This may make sense if you have children going to college, so you show less income on all the college loan applications.

The partial lump sum may also be a great option to help reduce tax toxicity, give you more control of your assets and also ensure the money goes to your loved ones without involving a pension provider or worry about their solvency. If you have a pension with a partial lump sum option, this is an advanced planning strategy that is important to investigate.

In conclusion, when you are making a pension decision it is important to take your time and consider how this option will affect your loved ones. You must consider taxation now and in the future, think about where you are going to live and be aware of advanced planning considerations that could be affected by the pension option you select today.

Craig Ferrantino is a registered representative offering securities and advisory services through United Planners Financial Services member FINRA, SIPC. Craig James Financial Services and United Planners are not affiliated. Materials discussed are not to be construed as specific tax or legal advice and are not a recommendation to buy or sell any securities.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Craig J. Ferrantino, Certified Financial Fiduciary® and Certified Wealth Strategist®, is the founder and president of Craig James Financial Services, LLC. He began his career at JP Morgan Private Banking Group, managing assets for high-net-worth clients. With over 32 years in the financial services industry, Craig has expertise in corporate finance, asset-backed securities and developing country asset trading. He has worked at Smith Barney and A.G. Edwards, gaining extensive experience in financial planning.