What's the Difference Between a Pension and an Annuity?

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on August 10, 2023

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When it comes to saving for retirement, there are two main types of plans: pensions and annuities. Pensions are typically offered through employers.

You contribute a fixed percentage of your income, and your employer matches some of that amount.

The money is invested by the company, which takes responsibility to ensure you have a steady stream of income in retirement.

Annuities are investments with a life insurance company.

You pay a lump sum, which is invested in a portfolio managed by the insurer. In return, you receive a regular payment for the rest of your life (or for a set number of years).

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Pension

In a pension plan, employers contribute to the account of an employee as part of his or her compensation package.

In addition, some states offer public pensions for state employees and workers at certain types of private companies – often those who work in education or at nonprofits – but plans vary widely from place to place.

With a traditional pension, the employee doesn't see the money that goes into his or her account. It's simply deducted from each paycheck.

Employers manage the pension fund, with guidance from a board of trustees, and it is their responsibility to make sure there is enough money to cover promised benefits when employees retire.

In addition, employers may choose to match some portion of employee contributions, making the pension plan more attractive.

Who Should Use Pension?

Pensions are ideal for people who want the security of a guaranteed income in retirement.

They're also a good option for people who don't want to worry about making investment choices.

The downside is that you may not have as much control over your money as you would with other types of retirement plans.

And, if your company goes bankrupt or otherwise fails, you may not receive the retirement benefits you were promised.

Pensions are typically offered to full-time employees only, and they may have a minimum age requirement of 50 or 55 before you can draw benefits.

Early retirees will generally have to forfeit some or all of their pension payments.

Why Save Into a Pension?

With a pension, the more you save while working, the more you'll have in retirement.

Your employer may match some of your contributions, or you may get an annual raise that boosts the amount automatically.

And because employers manage the investments for you, you don't have to worry about making smart choices on your own.

If anything goes wrong, they're the ones who are on the hook.

Annuity

When you purchase an annuity, you give a lump sum of cash to an insurance company.

In return, the insurer agrees to pay you a guaranteed amount each month for either a set number of years or for the rest of your life.

The payment is guaranteed because it is backed by the financial strength and claims-paying ability of the issuing insurance company.

You can choose from a variety of payout options, including a single payment that lasts for the rest of your life, payments that last for a certain number of years or payments that come at fixed intervals, such as monthly, quarterly, semi-annually or annually.

Who Should Use Annuity?

Annuities are ideal for people who want to plan for a steady income throughout retirement.

They're also a good option for people in poor health, since the annuity is backed by the insurer and offers guaranteed lifetime payments.

Annuities can be complicated and expensive, and they come with surrender charges that provide an income stream but reduce your eventual payout amount.

As a result, annuities are best suited for people who plan to hold them until they die. In addition, annuities typically have a minimum purchase age of 18 or 21.

Why Save Into an Annuity?

An annuity offers a guaranteed income for life, which can be helpful if you're worried about outliving your money.

The payments are also tax-free, which is a big benefit if your income in retirement will be lower than it was during your working years.

Unlike pensions, you have control over how and when you receive your payments.

An annuity also offers the ability to withdraw money penalty-free for certain expenses, such as college tuition or a first home purchase.

An annuity gives you an annual payout that is the same every year, even if your investment account balance goes up and down.

Because of this steadier payment schedule, it's not ideal if you're hoping to supplement your retirement income with investments.

Key Differences Between Pension and Annuity

The following are key differences between pensions and annuities:

  • Pensions are typically offered to full-time employees only, while annuities can be purchased by anyone.
  • Pensions are funded by employers, who manage the investments for employees, while annuities are purchased with personal funds.
  • Pensions offer a guaranteed income for life, while the payments from an annuity are not guaranteed to last for your entire lifetime.
  • Pensions typically have a minimum age requirement of 50 or 55, while annuities have a minimum age requirement of 18 or 21.
  • Annuities are tax-deferred accounts with high fees, while pensions are tax-deferred accounts with usually lower fees.
  • Pensions rely on you providing proof of age to claim benefits, but death benefits can pass on to your spouse even if he or she wasn't named in the plan, while annuities do not.
  • Pensions come with a surrender charge if you decide to cancel the plan, while annuities do not.
  • Pensions can be cashed out in a lump sum, but annuities cannot.

The Bottom Line

Both pensions and annuities have their benefits, so it's important to consider which option is best for you.

If you're looking for a guaranteed income for life, a pension is a good choice.

However, if you want more control over your payments and the ability to withdraw money penalty-free, an annuity might be a better option.

Annuities are also a good choice for people in poor health, since they offer guaranteed lifetime payments.

Remember, both pensions and annuities come with fees, so be sure to do your research before making a decision.

Pension vs Annuity FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.

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