Over 90,000 Ford Employees are facing a major decision: What to do with their pension.
Should they “play it safe” and continue to take the monthly distributions?
Or they take control of the money by rolling their pension into an IRA?
Lately, I’ve had several clients that are faced with the same dilemma.
When you retire and you have a 401k, then the choice is usually pretty simple- roll the 401k over into an IRA.
There are some exceptions to the rule -under age 59 1/2 and if they hold employer stock- but usually that’s the way to go.
What happens if a pension is involved?
Pensions will typically pay you an income for the rest of your life and then pay your spouse half of the amount for the rest of her life. If you don’t choose the annuity option, then the only other choice is to take the the lump sum option.
The lump sum option will allow you to take a big chunk up front and then roll that over to an IRA. You then are in control of how much you take per month as your retirement income.
Let’s take a look to see if it makes sense to roll over your pension into an IRA.
Before I continue, I should say that not all pensions are allowed to take the lump sum option. One quick example that comes to mind (at least in my region) are teachers. Most teachers only option is to take the monthly annuity benefit.
1. Financial Strength of Your Company
Deciding on whether to choose the lifetime income option vs. the lump sum might be as easy as evaluating the overall financial strength of the company you work for. As I have mentioned before in a previous post “Company is Going Bankrupt, What About My Pension“, your pension is insured by the PBGC (Pension Benefit Guaranty Corporation) , but it’s only up to $54,000 and that’s only if you retire at 65. Over and above that, then you are out of luck. Any pension amount that is over the $54,000 limit will make the decision to take the lump sum more attractive.
2. How is Your Health?
Does your family have a history of illness? If so, then taking the lump sum and rolling it to an IRA might be the most viable option. What’s the point of having a income for the rest of your retirement if you are only in retirement for a few short years?
I have a client whose never married friend had worked for a company for almost 30 years. When that person retired, they optioned to take the the annuity option and receive monthly payments. Just after three months of receiving their checks they unexpectedly passed away.
Guess what happened to the remainder of the pension benefit? It all went back to the company since they didn’t have a spouse to pass it on to. If they had rolled the pension into an IRA, they could have elected another family member to receive it or at least donated it to a charity or their church.
3. Beneficiary Minded
Most pensions work in that you (the employee) will receive an income stream for the remainder of your life. When you pass, your surviving spouse will receive half of the amount you received. (Some pensions do allow for your spouse to receive the full benefit, but typically you would have had to take a lesser amount in the beginning).
If your spouse predeceases you, then there’s no more to be paid. Same when your spouse passes- the payment stops with him or her. If you have surviving children, they will not receive a dime from the pension.
By opting to roll over your pension into an IRA, you will at least have the option to pass the remainder (if any) to your heirs. Also, if done effectively, they might be able to stretch the IRA over their lifetime.
4. Lump Sum Pension Payment Vs. Monthly Benefit
The last determinant is just like formerly called Puff Daddy’s song says, “It’s All About the Benjamin’s“. You need to closely analyze how much the lump sum pension benefit option vs. the monthly benefit. Let me highlight two situations where it the choice was fairly obvious.
I had one client who was offered an early buyout on his pension. He was almost 55 yet so he could start taking the payments immediately. The monthly benefit that they were offering was approximately $3000 per month. He had elected to choose a lower amount (the $3000) so that his spouse would receive the same amount for her lifetime. That wasn’t a bad option, but just to be sure, let’s look at the lump sum amount.
The pension was an older one that was more beneficial to tenured employees so the lump sum amount was only around $250,000. I say “only” because assuming no growth on the dollar amount, then the client would have completely exhausted his pension in just under 7 years right before he turned 62. In this case it was a no brainer to elect the guaranteed monthly benefit.
Another client had just turned 62 and her company was offering her a lump sum amount of $600,000. Not to bad, but let’s look at the monthly benefit. The monthly benefit amounted to $4,000 per month ($48,000) per year. Thus far it’s not such a clear cut decision. What made it crystal clear was that the client has had a 401k with the same employer for just over $200,000 and had a sufficient emergency fund plus minimal debt. On top of that, they had 3 kids in which they desired to pass an inheritance to. Believing that they would never outlive their retirement nest egg, it may complete sense to roll over the pension into an IRA.
Before 59 1/2- In Service Distribution
One last point that I should mention is that you don’t have to wait until you officially retire to roll your pension over. Once you reach the IRS’s magic age of 59 1/2, you can elect to do what’s called an In Service Distribution. Even if you plan to continue to work, you can elect to roll over your pension amount into an IRA. Your pension will then to continue to accrue with your employer and you have complete control of your money outside of your employers hands. This also works with 401k plans as well.
Deciding on the fate of your pension is a very important decision. Review your options more than once and seek council from different parties. I suggest meeting with a Certified Financial Planner and a CPA to help decide which option is best for you.