How are pension amounts calculated?

Pension benefits, which vary, are typically calculated based on the number of years you’ve worked for a company multiplied by your average salary over the last three to five years. This figure is then multiplied by a factor known as the “multiplier,” a percentage of your final average salary you’ll receive as a retirement benefit. For example, if the typical multiplier is 2% and you work for 20 years with a final average salary of $50,000, your annual pension would be calculated as follows: 20 years × $50,000 × 2% = $20,000 per year.

Is my pension guaranteed to pay out?

Honestly, it depends! Most people feel secure knowing they won’t be affected should their employer go bankrupt, as the Pension Benefit Guaranty Corporation (PBGC)—a federal agency designed to protect most private-sector pension plans—often fully replaces payments up to specific age-based limits. For example, the most recent guarantee for individuals aged 65 is a maximum of $7,431 per month. The median private pension benefit for those aged 65+, meanwhile, is just over $11,000 a year. Those with a public pension also enjoy peace of mind knowing every state provides some form of legal protection for public retirement benefits, with states likewise having the ability to raise taxes as necessary to address any pension-funding deficits. You may have cause for concern, however, if your pension is associated with a religious institution (as these are not typically covered by the PBGC). The same applies to professional service employers (e.g., doctors and lawyers) who don’t have at least 25 active participants following the enactment of the Employee Retirement Income Security Act (ERISA).

Are pensions taxable?

Yes, individuals who receive a pension are required to pay income tax in the year they withdraw funds (lump-sum payments are often taxed all at once while annuity payments are taxed as you receive them). This includes federal income tax at the normal rate and, depending on where you live, perhaps also state income taxes.

Which states don’t tax pension income?

If you have a pension, all U.S. states except Alabama, Alaska, Florida, Hawaii, Illinois, Iowa, Mississippi, Nevada, New Hampshire, Pennsylvania, South Dakota, Tennessee, Texas, Washington, and Wyoming will tax your pension in 2025.

Are there any drawbacks to receiving monthly pension payments?

While monthly payments are often a solid choice, their primary drawback is that they typically don’t offer any protection against inflation once you begin receiving them and thus often lose purchasing power over time.

How to Choose Your Pension Payout Options

If you’re fortunate enough to have a pension plan, you’ll eventually need to choose how to receive your benefits: deciding whether it's better to take a lump sum or otherwise opt for monthly payments, also known as an “annuity” or “stream payout.” Should you opt for the latter, you’ll need to carefully consider available options—especially if you’re married or have dependents—and ensure you make the right decision as the path you choose is typically irrevocable and thus can’t be changed. This post aims to give you clarity in your decision-making process with respect to pension payout options.

Is it better to take a monthly pension or lump sum?

Your first decision is to determine whether an annuity (monthly payments) or lump sum (all benefits paid upfront) is more appropriate for your needs. If you believe you can make more money investing on your own, already have sufficient sources of retirement income, and/or are in poor health and don’t expect to live very long, a lump-sum payment may make the most sense. You may also find a lump-sum pension appealing if you’re worried about your employer’s financial stability (particularly if your pension lies with a religious institution) or you want to protect your legacy as you can leave any remaining assets to your children or other heirs—whereas monthly pension payments cease when you or a surviving beneficiary pass away.

On the flip side, lump-sum options are often least appropriate for married couples, spenders who won’t save or reinvest the money, and/or those worried about outliving their retirement savings. As you can see, the choice is highly individualized and thereby not always clear-cut. Click here to read about the pros and cons of lump sum offers in more detail. For the purposes of what we’ll go on to discuss in this article, let’s assume you ultimately decide to move forward with monthly payments.

Annuity distribution options for your pension

When reviewing the forthcoming list of typical monthly annuity pension options, keep in mind most service providers give you the ability to calculate your monthly benefit directly within their website portals—meaning you can view all tradeoffs in exact dollar amounts for each option.

Single-life annuities

Although this option typically offers you the highest monthly benefit, payments stop when you pass away as funds are only paid out to one individual (you). This option is often an excellent choice if you’re single with no dependents. Married individuals, on the other hand, should know it has limitations (with no payouts for surviving spouses) and thus assess other sources of retirement income to determine spousal support. If you expect to outlive your spouse, though, this choice is a sound one as it allows you to maximize your benefits.

Joint and survivor plans

Joint and survivor plans offer a benefit payment lower than that of a single-life plan as a percentage of this passes on to your spouse (or another designated beneficiary) for his or her lifetime after your passing—the most common options allowing you to choose either 50%, 75%, or 100% of your benefit payment in doing so. The larger the amount chosen for the survivor, the smaller the monthly payment. If you select a 100% joint and survivor plan, for example, your monthly payout will rank lowest among all options while giving your surviving beneficiary the most robust financial security.

Some retirement plans offer a “pop-up” benefit option accounting for the possibility that a retiree may outlive his or her spouse, essentially a joint and survivor annuity clause that allows your pension payout to revert (or "pop up") to the higher single-life annuity amount should your spouse pass away before you. This typically comes with a cost, however, resulting in lower monthly pension payments for the retiree while his/her spouse is alive.

Joint and survivor options are often best suited for individuals who are married or older and/or in poorer health than their spouse.

Term/period certain annuity

To help reduce the risks of premature death while still receiving a higher payment than joint and survivor options, you can choose a single-life annuity with a term or a guaranteed period. This type of contract gives you benefits for a set number of years—commonly 5, 10, or 20—rather than over your entire lifetime. Should you pass away before the end of the term, payments continue for the remainder to a designated beneficiary (e.g., your spouse).

This option offers the reassurance of knowing exactly how many payments you and your beneficiary will receive over time. While monthly payments generally fall between those of single-life annuities and joint and survivor options, you might receive higher monthly payments than a standard single-life option (especially if the payment period is shorter than your life expectancy). There are drawbacks to consider, however, including that you may face financial challenges due to a lack of regular income should you outlive the term.

Finally, term/period certain annuities are also suitable if a surviving beneficiary only requires income for a specific period of time.

Annuity with accelerated payments

If you plan to retire before you’re eligible to claim Social Security benefits at age 62, you may face a temporary gap in your retirement income. Accelerated payments (also known as the “level income option”) can help bridge this gap, initially providing you with a higher pension that then drops to a lower amount once Social Security benefits kick in. This option ensures pension recipients have stable income during retirement.

To illustrate this concept, let’s assume you retire from your company at age 55, but your monthly Social Security benefits don’t begin until age 62 (estimated at $1,500 per month). If you expect to receive a monthly total of $4,000 from both your pension and Social Security, your pension would initially pay you this amount beginning at age 55 but then drop to $2,500 at age 62.

Joint and survivor options are also available, depending on your specific plan, so it’s important to understand how these benefits are calculated as not all pension plans are the same.

How to maximize your pension income with life insurance

Married couples often explore options to maximize their pensions, one of which involves leveraging a portion of the difference in payouts (between a single-life and joint and survivor payout) to purchase a life insurance policy. In some cases, life insurance offers a larger spousal benefit and greater flexibility by allowing your spouse to pass money on to heirs. This option may not work if you’re in poor health, however, as underwriting—commonly requiring a medical exam—is necessary for qualification.

In sum: how to choose a pension payout option

When deciding which monthly pension payout option is best for you, it’s important to weigh many factors. Want to ensure your spouse has income during retirement? Joint and survivor plans are perhaps more suitable than single-life options. Since your pension is likely just one source of your retirement income, it's crucial to take a comprehensive approach and understand how your income sources can work together to maximize your retirement funds—with a financial advisor particularly helpful in this regard. Weighing a one-time buyout instead? See our guide to the lump-sum pension offer.

Still unsure of which payout option to take? Schedule a FREE discovery call with one of our CFP® professionals to get your questions answered.

Reviewed for accuracy

Paul Muller, AEP®, CFP®

Founder and Relationship Manager at Vision Retirement, with 30+ years in the financial industry.

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FAQs

Pension benefits, which vary, are typically calculated based on the number of years you’ve worked for a company multiplied by your average salary over the last three to five years. This figure is then multiplied by a factor known as the “multiplier,” a percentage of your final average salary you’ll receive as a retirement benefit. For example, if the typical multiplier is 2% and you work for 20 years with a final average salary of $50,000, your annual pension would be calculated as follows: 20 years × $50,000 × 2% = $20,000 per year.
Honestly, it depends! Most people feel secure knowing they won’t be affected should their employer go bankrupt, as the Pension Benefit Guaranty Corporation (PBGC)—a federal agency designed to protect most private-sector pension plans—often fully replaces payments up to specific age-based limits. For example, the most recent guarantee for individuals aged 65 is a maximum of $7,431 per month. The median private pension benefit for those aged 65+, meanwhile, is just over $11,000 a year. Those with a public pension also enjoy peace of mind knowing every state provides some form of legal protection for public retirement benefits, with states likewise having the ability to raise taxes as necessary to address any pension-funding deficits.
You may have cause for concern, however, if your pension is associated with a religious institution (as these are not typically covered by the PBGC). The same applies to professional service employers (e.g., doctors and lawyers) who don’t have at least 25 active participants following the enactment of the Employee Retirement Income Security Act (ERISA).
Yes, individuals who receive a pension are required to pay income tax in the year they withdraw funds (lump-sum payments are often taxed all at once while annuity payments are taxed as you receive them). This includes federal income tax at the normal rate and, depending on where you live, perhaps also state income taxes.
If you have a pension, all U.S. states except Alabama, Alaska, Florida, Hawaii, Illinois, Iowa, Mississippi, Nevada, New Hampshire, Pennsylvania, South Dakota, Tennessee, Texas, Washington, and Wyoming will tax your pension in 2025.
While monthly payments are often a solid choice, their primary drawback is that they typically don’t offer any protection against inflation once you begin receiving them and thus often lose purchasing power over time.