Do I take lump sum or monthly payments?[ Edited ]
I was recently offered a lump sum payment of my pension plan. If I take the lump sum and roll it into an IRA versus taking a direct payment, will I have to pay taxes up front or when I reach retirement in a couple years and begin withdrawing from the IRA? What is the maximum amount a person is able to put into an IRA at one time? Thanks
This is a BIG decision. Let's look at the mechanics of how it will work and then review a number of factors you'll want to consider as you decide how to move forward in a manner that's right for you and your situation. Before we get too deep into it, I would suggest that before you make this decision you might benefit from talking with a financial planner to evaluate your options.
You're making the choice between a regular monthly payment that will last for your lifetime (and perhaps for that of your spouse) vs. a lump sum payment which you will control and be flexible to use as you see fit. If you take the lump sum and roll it directly into an IRA there will be no immediate tax consequences. However, your withdrawals from the IRA will be taxed as ordinary income. Since the money is being moved into the IRA via a rollover from your employer plan there is no limit as to how much money can be put into the IRA (contribution limits do not apply to rollovers).
Alright, now that I've addressed your specific questions, here are some questions you'll want to consider as you make your decision:
Is the lump sum a fair value? To answer this question you can simply contact USAA and/or some other annuity providers and get a quote on how much you would need to purchase the amount of monthly of income (with the same survivor benefit option as your monthly pension) provided by your pension. How does this number compare with the lump sum you're being offered? Would it take a lot more money than is being offered in the form of a lump sum to duplicate the monthly income your pension provides or vice versa.
What fits best into your retirement plans? Ideally during retirement your Social Security and other guaranteed streams of income (like this pension) will cover your regular fixed expenses. Retirement saving in IRAs, 401(k)s and other vehicles can then be used to supplement your fixed income. Have you mapped out your anticipated retirement spending and balanced them against your income? Depending on your situation it could be that one choice or the other (monthly payments vs. lump sum) works best for you. Remember, if you take a lump sum you could use a portion of the money to buy a monthly income stream and use the rest to supplement your fixed income.
Does your monthly pension include cost of living adjustments? The answer to this question will have a significant effect on the value of the monthly payments. A cost-of-living adjustment applied over decades of retirement is not something to forego lightly. A financial advisor could help you put a price tag on this feature.
Are you prepared to assume investment responsibility? One aspect of a pension that many folks I've worked with like is it just shows up in their bank account. They don't need to worry about investment allocation, fluctuating markets or the idea that they may run out of money. How do you feel about this?
What works best given your health and family situation? A lump sum could make more sense if one of your primary goals was to pass on money to your kids or grandkids (typically a pension can provide protection for your spouse, but not beyond that). If you are single and have health issues, a lump sum may be more attractive.
Hopefully, that discussion provides you some food for thought, but again I want to emphasize that this is a great time to give us a call for help. Good luck!