About two months ago I got an unexpected “time-sensitive” letter from my former employer notifying me that they were offering me an early buyout of my pension. You see I'd left my former employer after 11.5 years of employment and had accumulated a pretty good nest egg pension. In my mind I considered this “cigarette money” (and I don't smoke), and didn't really have any expectation that 100% of it would be there at retirement, but would be nice to have (kinda like Social Security).
The pensions for many companies is a huge liability and is weighing a lot of companies' bottom line so much so that many companies are having to fund (additionally) these pensions. For some, this is to the tune of $300+ million in a single year! Not chump change for any company, so I don't blame them for trying to buy out people's pensions.
In my circumstance, the letter came with 4 options, and really had me thinking! For a guy who writes a personal finance blog, I thought I would have had a canned answer as to what I'd do if I'd ever come into a sum of unexpected money. Not having a clear answer as to what to do I did what any normal PF blogger would do…I called my mother-in-law. She just so happens to be my accountant too! :) I had to find out what options would affect our taxes the most, and what would be her recommendation.
Here are the options we discussed and the pros and cons I weighed in making a decision.
- Pros: Immediate access to a large sum of money that I could diversify into alternative (after tax) investments or I could splurge on some impulse buy.
- Cons: A large tax bill and penalty associated with the early withdrawal. Forgoing the pension monthly payout from 65 years old to death.
Direct Rollover to an IRA
- Pros: It'd allow me to be in charge of my retirement investments. It would guarantee me a certain amount of my pension, since most pension benefits aren't a guarantee. Also it would allow me to delay the tax consequences and would avoid the penalty of early withdrawal.
- Cons: Again I'd be forgoing the pension monthly payout from 65 years old to death.
Life time pension (from Jan. 1, 2013 to death)
- Pros: It would provide me with a monthly annuity (pays me in cash monthly), and would allow us to diversify this money into other investments.
- Cons: This is a much smaller monthly payment compared to waiting till I'm 65. If the pension is frozen and taken over by the Pension Benefit Guarentee Corporation (PBGC), then my payouts would be cut significantly (by 25% or more). It would also require us to pay taxes on these monthly payouts, and early withdrawal fees.
Keep Money in the Pension (stay put)
- Pros: My pension guaranteed that I'd earn 6.52% over the life of my annuity (compounding interest), and would help avoid the immediate taxes and withdrawal penalties. It'd also supplement my 401k and IRA withdrawals at retirement to help me during retirement.
- Cons: My pension isn't guaranteed to be there at 65 years old, and could go unfunded if a severe downturn happens. If taxes are higher at 65, then it could possibly hit me at a higher tax bracket (big unknown).
When I talked with my mother-in-law I realized that this decision could really help accelerate our retirement savings or could easily be squandered by cashing it in (which I'd bet people do). In making the decision the old saying:
A bird in hand is better than two in the bush!
…came to mind, and helped make my decision clearer. To me ultimately what the decision came down to was 1) I could control my retirement investments, 2) I was guaranteed the present principal investment, and 3) I could avoid the immediate taxes and penalties.
I'd be interested to hear from our readers and what would you do if you suddenly were presented the option of cashing in your pension? Or what would you do if you were presented with a large inheritance? What would your decision come down too?
I think I would roll it over into an IRA. It would give yourself piece of mind that the money will be there when you retire and you can invest it how you want.
Take the cash ,pay your taxes and bury it in a can..Its cold hard cash that you wont be taxed on if they dont know you have it.. Oh and buck up and be strong minded, pretend it isnt yours til you retire..Lets face it your money is already over taxed..Your taxed when you earn it, your taxed when you save it and, your taxed if you invest it.. if you die before 65 your kids are taxed when they inherit it. How many more times do you want to pay taxes.. As you said a bird in hand..well keep it there…
I think it depends on your own situation and retirement goals. We are working towards owning positive cash flow rental housing to fund our retirement. Therefore, for us, I would choose to roll over the pension into an IRA so when we leave our wage paying jobs and are maybe at a lower income level we can choose to pay off a rental home with hopefully minimal tax. This could possibly increase our monthly “passive” (Hah!) cash flow by eliminating a mortgage. Of course we would still have to pay property taxes, insurance and maintenance which is about half the rent in our area.