One of the most difficult decisions employees face when leaving a job is whether to roll over their company pensions to an IRA.
If you’ve worked at the same company for many years, that pension balance is likely to be substantial, so this could be an important decision.
If you choose to keep the money in the pension, it would be distributed to you as an annuity, typically starting at age 65. That means you would receive guaranteed payments for the rest of your life (and optionally your spouse’s life as well, if he or she outlives you). Plus, you would retain complete asset protection from creditors: Think O.J. Simpson and the money he’s been able to keep despite having a $30 million wrongful death judgment against him.
On the downside, the guaranteed payments could be reduced if the company were to go bankrupt. Not to mention, because they are fixed payments, they wouldn’t keep up with inflation and thus would likely become less sufficient the longer you live.
If you keep everything in a pension, you would lose all control over the principal. You would be unable to pass it on to your heirs or use it to buy a second home, for example.
The alternative is taking a lump sum calculated as the present value of an estimate of the future stream of payments based on current interest rates. This would allow you to reinvest the money or use it for any purpose you choose, avoiding any concerns associated with the future viability of the firm. But the creditor protections would be weaker, and if you live an exceptionally long life and fail to manage the money properly, you could completely run out prematurely.
Best of both worlds
The IRS recently finalized new rules that enable you to have the best of both worlds. Recognizing that it is not beneficial to force participants to make an all-or-nothing choice, the IRS now allows pensions to pay out a partial lump sum, in effect splitting the proceeds into some amount of immediate cash together with a lifetime stream of payments from the remainder. How much you allocate to each would be up to you.
This is an excellent change that has been too long in coming. The rule was first promoted in 2012 and took more than four years to become finalized after much public comment. However, just because flexibility is now permitted does not mean plan sponsors are required to offer it. There are still plans, in fact, that do not even allow lump-sum distributions. For those that do, it is totally up to the plan sponsor to decide if and when to implement the change.
Such flexibility can make your retirement planning more complex. If you think the decision to take a lump sum or an annuity from your pension is challenging, imagine how much more difficult the decision becomes with the new benefit. Your choice is no longer either-or, but rather how much to allocate to each.
If you expect to face such a choice, be sure to create a detailed retirement plan before leaving the company. It is only by comparing the alternatives in the context of all of your future goals that an appropriate lump-sum/annuity mix can be determined.
The new capability definitely enhances the value of a pension plan as a flexible source of retirement funding. If you are fortunate enough to work for a company or public-sector entity that offers one, find out if your plan will be getting this enhancement.