At retirement, you may need to choose how to take your benefits. There are several possibilities you might consider:

  1. Choose an annuity option offered through your employer retirement plan
  2. Roll over the funds to an IRA
  3. Take a lump sum distribution and pay tax on the distribution
  4. Leave the funds in your employer’s retirement plan
  5. Move the funds to a new employer plan
  6. Complete an in-plan Roth conversion
  7. Convert the funds to a Roth IRA

With a defined benefit plan, or a traditional pension plan, your company will calculate the lump sum and/or annuity benefits based on years of service and a number of other factors. Interest rates affect this calculation. As interest rates rise, the value of lump sums decreases. Keep this in mind as we approach a period where it is likely that interest rates will rise. Be sure you understand how both the annuity and lump sum are calculated because it could affect when you decide to retire.

With a defined contribution plan, like a 401(k) plan, you have been making contributions over the years and your company may have too. You’ll know the current value of the plan because you will get statements. If your company offers an annuity option at retirement, they will calculate that for you. You generally have the option to keep your money in the company plan or roll it over to an IRA. Be sure you weigh the costs in the company plan versus outside investments in an IRA. Also consider how the choice of investments in either option affect your investment strategy.

Factors affecting an annuity:

  • Choose an annuity if you want to lock in a stream of payments until you die. As long as the insurance company that issued the annuity is solvent, you’ll have a guaranteed income without worrying about the stock or bond market.
  • Choose an annuity if longevity runs in your family. If you are in good health and think you might live a very long life, your annuity keeps paying while you are alive.
  • Pay attention to whether the annuity has an inflation factor that increases the payment as inflation rises. It is increasingly common to find this type of annuity today.
  • If you decide to take an annuity, think about what happens when you die. If you are married, the default option will be a 50% joint and survivor (J&S) annuity. Your spouse will get 50% of your benefit when you die. If that will put a crimp in your cash flow plans, choose a higher J&S benefit. We typically look at 100% joint and survivor options when running retirement projections because the amount is the same throughout both lifetimes, although it is lower than a single life annuity payment.
  • The Pension Benefit Guaranty Corporation (PBGC) guarantees pensions up to a certain limit each year. (For more on how much is covered, go to www.pbgc.gov.) Be cautious about over-relying on this guarantee. The PBGC has been hit hard with many corporate bankruptcies in recent years.

Factors affecting a lump sum:

  • Take a lump sum if you know you have health problems. If you don’t think you’ll live a long time, your heirs might be better off with the lump sum rollover.
  • Take a lump sum if you need more flexibility with your assets. If you know you’ll need larger amounts from time-to-time, you may not want to lock in an annuity stream. Or perhaps you can take an annuity with part of your money and keep another asset base outside the annuity.
  • Take a lump sum if you want to invest and control your retirement nest egg. You will have more investment choice and greater flexibility with a lump sum rollover.
  • Don’t take a lump sum and NOT roll it over. If you do that, you’ll owe tax immediately on the whole amount.

A variety of factors influence whether you should choose a lump sum to roll over to an IRA or an annuity that pays a stream of income. Your health history plays a role. Consider expenses of both strategies. Think about your own risk tolerance. Can you sleep at night and manage your own money? Do you have an advisor to do this for you that you know and trust? Take your time and weigh your options to make the best decision for you.

Of course, you can generally keep your retirement funds in your retirement plan at work. If your costs are low and you have sufficient investment choices, that may be in your best interest. Think about whether you’ll need financial planning advice, like how to best draw down your assets and the tax implications. You may have resources through work that can help you think through those decisions. Or you may decide that hiring an advisor is in your best interest.

Other less typical options include:

  • Moving the funds to a new employer plan. If you are retiring, this may not be an option. If you are changing jobs, it could be. But be sure to study the new plan and see what the costs and investment options are first.
  • Convert to Roth 401(k)/IRA. Some plans allow you to convert from a traditional 401(k) to a Roth 401(k). You’ll owe tax if you choose to do this (see http://www.rothira.com/blog/how-to-convert-a-401k-to-a-roth-401k). If you have a Roth 401(k), you can roll that over to a Roth IRA. Keep in mind you have to take required minimum distributions at age 70 ½ from a Roth 401(k), but not a Roth IRA.

Disclosures
The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.