Because pension and retirement annuities accumulate savings for a similar purpose, they can be hard to tell apart. Here's what each plan consists of and how to distinguish them.
People want to be financially stable after they reach retirement age. To start putting away money for the future, workers can choose from many savings and investment vehicles. Pension plans and retirement annuities are two of the most popular saving schemes. Many people struggle to understand what they actually are mistake them for the same thing.
Both are meant to be a source of income during retirement; however, each plan means something specific. First, let's look at "pension" and "retirement".
A pension is an amount of money that a person may receive on a regular basis over a certain time for retirement, widowhood, disability and other reasons (depending on the country). But retirement is when someone has reached a certain age or number of years worked and, therefore, can stop working and receive their pension. Both pension and retirement are closely related.
How does a pension plan work?
Pensions plans are investment and long-term savings products. Customers make regular or one-off contributions to them, which pension plan managers invest in financial assets to get a return, mainly through pension funds. The fund manager and the custodian normally deduct a fee.
When pension plan beneficiaries retire, they receive the invested savings and the return they generated in either a lump-sum payment or an annuity (a regular payment). In some countries, the law might limit the amount people can contribute to a pension plan each year.
If you want to learn more, this article (in Spanish) on Tu Futuro Próximo, a blog by Santander Consumer España, tells you everything about pension plans.
How does a retirement annuity work?
A retirement annuity is like an insurance policy. However, its purpose is to save money to insure funds over a particular period of time. Annuitants pay a given amount regularly or through a single premium to receive the amount saved plus the return from the insurer as income.
The three differences between a pension plan and a retirement annuity
The main difference lies in the nature of each product: a pension plan is a saving and investment product, and a retirement annuity is an insurance contract. Let’s focus on three practical questions that spell out their differences even further.