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Former employer holds money in defined benefit plan. Now a few options are given: leave it in defined plan, take as cash, rollover to IRA or put in lifetime annuity and start taking money now. Which is best?

Small amount of value- Lump Sum value is $7141.67. If left in Defined Benefit, it would be $172.12 per month starting at age 65y0. I am 45yo right now. Money was not taxed; so taken as lump sum means taxes.

Jul 20, 2012 by Matthew from Norwalk, CA in  |  Flag
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4 votes

Hi Matthew, it used to be that I advised clients to stay with their defined benefit plan and eventually take an annuity payment at retirement. But after seeing the airlines have financial trouble over the last decade and cut their employee pensions, seeing GM and Ford offering current retirees the choice to opt out of their annuity payments, and Stockton, CA filing for bankruptcy and CUTTING currently retired employees annuity payments (that's been unheard of until now), I think you'll eliminate future uncertainty by rolling the lump sum to an IRA. Doing so accomplishes a couple things.

First, you avoid current income taxation since you are 45, and you preserve this money for retirement (which was its original purpose)--always a good thing!

Second, you eliminate any uncertainty about what may happen financially to your former employer at some point in the future. I cannot imagine a Stockton, CA city employee retiring in say the early 2000s and EVER thinking their pension payments would be cut. So I think it's now best to cut your ties with former employers (when you terminate, for whatever reason) and take control of your own retirement funds by rolling them to your own IRAs.

Food for thought! Mike

Comment   |  Flag   |  Jul 20, 2012 from Orland, IN

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Hi Matthew,

You know I don't know your personal financial situation all that well - but IF you have a new job (or get one) that has a defined CONTRIBUTION plan (ie - 401(k), 403(b), etc) then I would generally lean toward rolling it THERE, which you didn't list as an option, but you should be able to do. If you can't - or if you don't want to, then rolling it to an IRA seems like the best answer.

My reasoning for rolling it to a new employer plan is that if you retire, or leave your next employer, you have access to the money with no early withdrawal penalties beginning at age 55. If you roll it to an IRA, you have to wait until age 59 and 1/2 before you can access the money without penalties. So, in the interest of flexibility and growth, the new employer plan seems like the best option.

IF, however, you find that your new plan has really high fees (check them on Brightscope) or has a terrible investment lineup - then you may want to just forego the flexibility of getting the money early (age 55) and roll it to an IRA where you have virtually unlimited investment options.

Jon Castle http://www.wealthguards.com

Comment   |  Flag   |  Jul 20, 2012 from Jacksonville, FL

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George Cones, JD Level 20


If you don't think you will need the money anytime soon, you may want to consider rolling the money over into a IRA Rollover account. If you got a 7% return over the 20 year period, using the "Rule of 72" you could wind up with something like $28,000. If you made 3-4% each year while taking withdrawals you could approximate the $172.12, If you live to 85 (check out the social security life expectancy tables). So the defined benefit of $172.12 looks pretty good too. These are pretty reasonable assumptions: 7% return to 65 years, 3-4% return (due to more conservative portfolio) between 65 and 85 (your life expectancy). If some salesperson says you can make more than that $172 per month, make sure you understand what they are promising, and get that guarantee in writing.

Comment   |  Flag   |  Jul 20, 2012 from Wilmington, DE

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Eric Level 17

All of these options have pros and cons:

Leave it in:
Pro- Turn key. You do nothing. Guaranteed payments in the future. Con- You have no real growth potential and therefor the value of the benefit decreases in real terms due to inflation.

Take as Cash:
Pro- You get $7141.67 now to do what you wish. Con- You pay taxes on it now and it may get spent before retirement.

Rollover: Pro- You don't pay taxes now and you can invest it for 20 years. Simple rule of 72 states if you earn 7% annually you could quadruple your money in 20 years. (Rule of 72 is if you earn 7% a year you will double your money in 10 years, so in 20 years you would double and then double your double) This isn't guaranteed, but is only an example of growth potential. Con- It requires diligent investing and paperwork

Annuity: Pro- Like the defined benefit plan it guarantees an income stream. This one gives you a very small payment for your life starting now. Con- You have no real growth potential, you pay taxes on the income you receive, the value of the payments decrease with inflation.

This is very broad based, but I think it's a quick take on each option. Once again, I recommend talking with your advisor. If you don't have one, I recommend finding a fee only advisor in your area.

Comment   |  Flag   |  Jul 20, 2012 from Denver, CO

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Great answers from everyone here. This answer will drill a little deeper into one option for you.

You might want to transfer the money you’ve invested in one or more employer-sponsored retirement plans to an individual retirement account (IRA). An IRA rollover is an effective way to keep your money accumulating tax deferred.

Using an IRA rollover, you transfer your retirement savings to an account at a private institution of your choice, and you choose how you will invest the funds. To preserve the tax-deferred status of retirement savings, the funds must be deposited in the IRA within 60 days of withdrawal from an employer’s plan. To avoid potential penalties and a 20% federal income tax withholding from your former employer, you should arrange for a direct, institution-to-institution transfer.

You are able to roll over funds from an employer-sponsored plan to a traditional IRA or a Roth IRA. Everyone is eligiblefor a Roth IRA rollover as there are no income limits (although income limits still apply to contributions to a Roth IRA). Keep in mind that ordinary income taxes are owed on all amounts rolled over to a Roth IRA.

An IRA can be tailored to your particular needs and goals and can incorporate a variety of investment vehicles. In addition, tax-deferred retirement savings from multiple employers can later be consolidated.

Over time, IRA rollovers may make it easier to manage your retirement savings by consolidating your holdings in one place. This can help cut down on paperwork and give you greater control over the management of your retirement assets.

Distributions from traditional IRAs are taxed as ordinary income and may be subject to an additional 10% federal income tax penalty if taken prior to reaching age 59½. Just as with employer-sponsored retirement plans, you must begin taking required minimum distributions from a traditional IRA each year after you turn age 70½.

Qualified distributions from a Roth IRA are free of federal income tax (under current tax laws) but may be subject to state, local, and alternative minimum taxes. To qualify for a tax-free and penalty-free withdrawal of earnings, a Roth IRA must meet the five-year holding requirement, and the distribution must take place after age 59½ or due to death, disability, or a first-time home purchase ($10,000 lifetime maximum). The mandatory distribution rules that apply to traditional IRAs do not apply to original Roth IRA owners; however, Roth IRA beneficiaries must take mandatory distributions.

Comment   |  Flag   |  Aug 06, 2012 from Austin, TX

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Matthew - the threshold question is whether your former company's DB plan, and the company itself, are in a strong financial position. If the answer is no, then you should opt for the lump sum distribution and roll over the balance into an IRA. Several advisors have outlined the benefits of this approach and I would concur. You will retain maximum flexibility and control while eliminating all credit risk exposure to your former employer, without incurring any current tax liability.

However, if your former company and its defined benefit plan are financially strong and well-funded, then you should consider keeping the plan benefit. Here is why: let's assume you live for at least twenty two years after retirement, until age 87. This is a reasonable baseline assumption, and there is a high probability that you will live even longer, even assuming no further medical advances between now and then. The present value of the annuity benefit in this scenario, assuming a 6% discount rate, is about $7600. With a lump sum amount of $7142, you would need to invest at a compound rate of about 6.22% to produce the same monthly payments for the 42 year period from now, until you begin drawing payments at age 65, then until age 87. In my view, this is a fairly aggressive return requirement; there are no investments that can guarantee this level of return with a low level of risk. Moreover, with the defined benefit plan you would be getting the contingent annuity payments (if you live past age 87) for free. There also may be additional benefits that are embedded within the terms of the plan, such as a survivor's benefit, cost of living adjustments, minimum payout amount, and/or options to defer your pension start date in return for a higher nominal payout.

In short, if the plan and company are in good financial shape, I would not be too quick to abandon the plan, as you may give up a benefit that you cannot easily replicate. Feel free to respond with any follow up questions or comments. Good luck!

Comment   |  Flag   |  Aug 07, 2012 from San Francisco, CA

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