How to Take a Lump-Sum Pension
Any consideration of taking a lump-sum withdrawal from a pension plan should weigh two factors closely—taxes and penalties. Plus, you must consider how confident you'll be about sustaining that stream of income after you retire. There are strict limits on who can take a lump-sum pension. For example, retired military personnel or disabled people are eligible for a lump-sum payment but they cannot do so until they reach age 59 and half. Otherwise, they’ll be responsible for taxes and a 10 percent penalty. Once you reach the age of 70 and half, the penalty is waived but you’re still responsible for the income tax due on the entire amount of the distribution.
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Instructions
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Find out in what type of pension plan you have. There are different kinds, but most fall into two categories: Defined-benefit plans and defined-contribution plans. Ask your employer for a summary of your plan (this is usually handled by the human resources department or a benefits plan administrator).
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Determine what your monthly benefits will be upon retirement if you are in a defined benefit plan. To make an informed decision about choosing a lump-sum option, you’ll need to know how much money you would receive under a traditional pension plan.
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Calculate your defined-benefit payments based on your employer’s formula. Some employers pay a straight monthly benefit (say, $500), while others pay based on a percentage of your salary. For example, if you receive 2 percent of your average salary based on your last five years of service (you averaged $40,000 the last five years you worked), you’d receive $800 a month. Determine if a lump-sum payment would equal the amount of total monthly payments (and for how long).
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Estimate what your defined-contribution plan payments would be at retirement. Most defined-contribution plans are some form of 401(k) or IRA. However, The Pension Benefit Guarantee Corporation (PBGC) only guarantees defined-benefit plans and not defined-contribution plans.
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Determine how old you will be at retirement and if a lump sum would be advantageous. The inflation rate has outpaced the growth rate of health care costs for many years. If your defined-benefits plan won’t cover the increased cost of your health care, you may be better off taking a lump-sum payment.
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Figure out the difference between a lump-sum payment and an annuity-type plan. Factor in taxes and penalties. A defined-contribution plan, in particular, may pay you a reasonable lump-sum figure if your investment plan over the years has paid reasonable rates of return. Rolling over the lump sum into an IRA also offers tax benefits and the security of a monthly check.
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Tips & Warnings
Employers are the best source of pension information. Three out of four employees mentioned their employers as helpful in providing lump-sum information.
If you take a lump sum, check out the services of a retirement financial adviser. He can provide expert advice.
Financial self-discipline may be the most important factor if you choose to take a lump-sum payment. You will be responsible for your future financial security.
References
Resources
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