We were recently told that our defined benefits plan was being taken away. For those that are confused, a defined benefits plan is what is normally called a pension. For me, I haven’t been around long enough for it to really affect me. Some, who have been around for a very long time and are nearing retirement, it will mean a rather significant chunk of the money that they thought they would have for retirement will be gone. To their credit, our employer is doing it the right way.
Rather than just declaring the fund bankrupt, or letting it run until it was bankrupt, they’ve decided to shut it down gracefully. What that means is that those of us who are vested in the plan will receive a payout of the amount we have vested. And, as part of that, we need to decide what to do with that money. We have four options:
- Buy an Annuity. Annuities basically work like this: You give them a lump sum of money, and they agree to pay you a monthly amount back. The total of the payments is equal to some amount greater than the amount that you gave them. It’s usually based on current interest rates.
- Roll the money into the company 401(k). I’m already participating in the 401(k), so this would be a logical place to go with it.
- Roll the money into an IRA. Also a logical way to use the money. Could be rolled over into a Roth IRA as well. Either way, I have far more control of the money than I would in my 401(k). Also, I don’t believe I’d have to worry about IRA Contribution Limits if I roll it over.
- Take a cash payout. They’d just write me a check, minus the 10% early withdrawal penalty from the IRS.
I’ve ruled out option 1 as it doesn’t make any sense to do with the interest rates where they are. Most likely, I’ll be using option 2. But, I just can’t come to a concrete solution. If I take option 2, I add a significant amount of money to my 401(k). More is always better. But, I have no more control of that money than I do with the current money that’s in there. 
If I take option 3, I still retain the same amount of money in a retirement account, plus I have far more control of where the money is invested than I do in the 401(k). That’s also the con of this option though. I’m no investment expert. I could look to invest in a stocks and shares ISA but as a general rule, most of the investments I’ve made aren’t all that great. Which means it would have to be limited to EFTs and Mutuals which doesn’t afford that much more control than in the 401(k). The final option would be to take the money in a check. The big downside there is that the IRS takes 10% off the top as a penalty. Then, it’s counted as income which gets taxed as income. In our tax bracket, that could mean an extra 15% in tax liability. If it bumps us up into a new bracket, it could mean some of it could be 25% in tax liability. So, I’d pay an instant (or nearly so) 25-35% if I took a check. But, that still means I would receive a lump sum of several thousand dollars. That money could be used to pay off at least one credit card, if not two, and alleviate some of the monthly burden that our debt gives us.
I know that the safest (rightest) answer is to put it into one of the retirement accounts, but having the cash to dump some of our debt would also be very advantageous.
What would you do? If you were in my situation, would you play it safe and roll the money into your 401(k)? Would you take the cash and pay something off to reduce your monthly expenses? Tell me how you would handle this!
photo credit: House Committee on Education and Labor
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Because you are discussing roll-overs, I am assuming this pension money was a pre-tax contribution. I would immediately rule out option 4. Retirement money should be continued to be used for retirement (not paying off debt) and I don’t like penalties.
I also don’t like option 1 because you would be taking tax deferred dollars to buy another tax deferred plan (annuity). Two tax deferrals for the same dollar don’t help.
I, like you, am less than savvy as an investor, but I would still be prone to roll it into an IRA, simply because you do have more choices than with a 401k and because the IRA will be your anchor retirement plan as you go through life. What will you do with your current 401(k) if you switch jobs? And then the next time you switch jobs? See what I mean?
Good question. Being as I jumped in first, I am curious to see what others will recommend.
@joe,
That’s kind of where I’m leaning at the moment as well. Although it’s a toss up as to whether to go with the 401k or the IRA. and the cash is still very tempting, but yeah, penalties are no fun.
Would not choose an annuity or cash it out. I would look at what I already have in my 401k (fund-wise) and see if it needs balancing. For instance if you have 0 international funds, then I would put it into a International fund within the 401k.
I don’t think I would go with the Roth myself either. I would just stick with the 401k. (That is what I did about 10 years ago when I had this very same issue.)
Before dumping it into retirement I think it’s worth working out how much money would be saved by paying off a high interest debt early and then seeing if you can pay a little extra to other debt or retirement per month instead. As you are paying regular to retirement already I would take a lump sum and zap a debt….. Maybe that’s just me thinking short term though!
And that’s exactly why I get stuck a little on it, Forest. My 401k has done well recently, but it certainly isn’t showing the 17% I would get from paying down credit card debt. But, it’s the compound interest thing that slows that idea up as well.
One reason that I’m hesitating at all is that I’ve been reading Jacob’s Early Retirement Extreme book. Gives a person a new perspective on the things that we hold dear as pf bloggers.
I went through a similar situation almost a year ago. Our pension contributions were made with after-tax money, so I elected to do a rollover Roth IRA. This was the best option for me, because I wanted to keep these funds working for me in a retirement plan. (and I hope I explained this correctly; I actually spoke with my accountant about before I did anything to make sure it was done correctly).
In most situations, I would recommend rolling it directly into an IRA or your 401k, just so you can maintain the tax benefits, and you won’t have to pay any taxes, penalties, or other fees. As Joe mentioned, IRAs have more flexibility and give you more investment options than a 401k, which is why I chose that route. But a 401k will offer the same tax benefits and offers the benefit of having more of your investments under one roof, which makes it easier when you need to balance your portfolio.
Option 4 should be off the table for a completely different reason that no one has brought up. You can do option 2 or 3 AND THEN do option 4, but you can’t go the other way. In other words you can go for option 2 or 3 AND then decide to withdraw some and incur the same penalties and taxes (or you could get even fancier and withdraw some in tax year 2010 and then some in tax year 2010 thus keeping you in a lower tax bracket).
I don’t understand and I don’t think anyone has asked you yet – the annuity option, what kind of annuity is it? A fixed? Deferred? Immediate? Does it have Guaranteed riders? It could be used as your pension if you get a good illustration. However this leads us to the same conclusion as above, such that, if you deposit it into a traditional IRA you can then purchase an annuity (and possibly a better annuity).
So really it sounds like we are down to Options 2 and 3.
Then you come to the often battled 401(k) vs IRA. Most people love the IRA because of all the reason already listed. But, the 401(k) allows you to take a loan. So you could go to your 401(k) and take a loan at probalby 3 to 6% and pay off some of that debt and pay yourself back at a lower rate.
Just some long winded thoughts!
@Evan
Those are some excellent points, Evan. I think the absolute easiest answer for me is going to be to dump it right into my existing 401(k). I can’t help but be a little bit tempted to open an IRA with a self service broker and see what I can do with that money either. Recipe for disaster, I think, but the thought is fun. 😉
As for the annuity, the way I understood it, it would be an immediate annuity and taxable.
Hello BB – for me, right now, a cash out would be the best option. But that’s only because of certain preferences and circumstances existing *right now*. I would rationalize the lump sum as ‘found money’ and put it to best use, which currently would be towards buying hard assets like a good used lawn tractor, or a few acres of land out in the country. But that’s particular to my own situation. Yours might be/is different. You might have a creidt card debt at 19 pct rate that need paying off. Or, some urgent house repairs. In any event, an IRA rollover is probably a good option.
Noticed the dates on the post, but can’t stop myself from replying.
Rolling it over to an IRA is the textbook answer. However you need to consider whether it is time for professional help. ( not psych help, I hope) If you are not happy with the idea of choosing ETF’s or funds yourself, consider rolling it into a firm that will manage it for you on a fee basis. For 1% (or less) or a lump sum for a plan to do it yourself, it’s a cheap way to feel more confident and have someone else to blame.
What tips the answer to option 2 is where you said it was several thousand dollars. If you are young and have little saved in the 401(k) plan as ell, this is a nice boost you won’t regret.
For reader who say “several hundred thousand” or even tens of thousands, I’d suggest the IRA rollover provides certain flexibility. The option to convert a bit of money each year to Roth at 15% is one, the many other investing choices, another.
Since this article goes back a ways, what did you decide to do?
When I first got the total amount that I was supposed to expect, it was nearly 9k. As it got closer to the date, we got a more updated total of what it should be and it was closer to 3k. In the end, I decided that the money would be best put towards debt repayment, so we’re going to take the cash out and pay off a couple of credit cards, and a few medical bills. One never really knows what the correct answer is. There’s a mathematical best answer, and then there’s a best answer for that person. I don’t know, for 100% certainty, that this is either, but it’s a step in the right direction as far as our debt goes, so I don’t think I’ll regret it to awful much in the future if it turns out to not be the absolute best choice.