Options for Distributing FundsPlans must specify how pension benefits will be distributed once a participant retires. The two most common methods of distributing such funds are through annuities and lump-sum distributions. Occasionally participants may be offered additional alternatives. AnnuitiesRetirement plans may distribute benefits using several different types of annuities. The most straightforward type, a "straight life annuity," offers retirees in a defined-benefit plan the full benefit to which they are entitled for the remainder of their life; their survivors, however, receive no benefits after their death. Employers that provide defined-benefit plans are required to offer married participants a default option--a "joint and survivor annuity"--under which the monthly benefit is reduced during the annuitant's lifetime but continues to be paid to the spouse after the annuitant's death. Given a choice, most participants opt to maintain survivor's benefits at the same level as that provided during the annuitant's lifetime. Some plans, however, limit the survivor's benefit to 50 percent of the benefit paid while the annuitant is alive. If the retiree selects any distribution option other than a joint and survivor annuity, both spouses must acknowledge in writing that the surviving spouse will be entitled to benefits only for a limited time or not at all. Like defined-benefit plans, money purchase plans typically offer benefits in annuity form. More than one-quarter of 401(k) participants in medium-sized and large establishments could also select the annuity option in 1997. For them, that option locks in the account's value at the time of retirement and eliminates the risk that the investments will perform poorly afterward. Distributions as annuities also avoid the penalty tax (10 percent) on early payouts. Participants in defined-contribution plans whose employers do not offer an annuity option can, nevertheless, receive their benefits in that form: they can take a lump-sum distribution (see below) and roll it over into an IRA that is structured as an annuity by a life insurance company. Lump-Sum DistributionsSome employers permit retirees to receive a lump-sum distribution--a one-time payment that equals the actuarial value of accrued benefits. Lump-sum distributions are not common among traditional defined-benefit plans but are a typical feature of cash balance plans. In 2002, that distribution option was available to 48 percent of private-sector employees covered by defined-benefit plans, up from less than 25 percent during the 1996-1997 period. Because cash balance plans have not taken hold with state and local governments, fewer than one in 10 of those employees have that choice. The federal government allows no lump-sum distributions from its defined-benefit plans. By contrast, the vast majority of defined-contribution plans permit lump-sum distributions, and most recipients select that option. Retirees then typically roll the distributions over into IRAs, in which they continue to accrue tax-free earnings while the owner makes withdrawals as needed. Other OptionsAnother common option among defined-contribution plans is to receive benefits in installments for a fixed period. That option was offered to over 40 percent of 401(k) participants in medium-sized and large establishments in 1997; however, if beneficiaries receive such distributions before age 59½, they still incur the penalty tax. On the one hand, unlike an annuity, the option ensures that retirees (or their heirs) receive the full value of the account. On the other hand, the option carries the risks that assets in those accounts could decline in value and retirees could outlive their benefits.
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