Any reason not to take a pre-retirement pension lump sum payout?

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gophermobile
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Any reason not to take a pre-retirement pension lump sum payout?

Post by gophermobile »

I am 39 years old and married, and recently left a company that had a pension. It's not a huge amount - valued at about $68k currently. With their calculator, it says it will be worth around $178k by an official retirement age (65) which is less than 5% yearly growth.

I don't need the money now, but I would rather have control over it as I think I can earn a better return instead of letting it sit with the company for the next 20+ years. If I take the lump-sum payment now, I would need to pay taxes which would total around 30-34% for state + federal.

I am planning to retire early, possibly within next 5-10 years, so my taxes may go down though I don't think drastically. Overall my net worth is about 2 million, with 2/3rds in retirement accounts (401ks, ROTH IRAs). Another advantage I see is that this would shift some additional money out of retirement accounts and make it more accessible as I get closer to FIRE.

So...any good reason not to take the lump sum payout now and invest it on my own?
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mrspock
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Re: Any reason not to take a pre-retirement pension lump sum payout?

Post by mrspock »

Is the pension adjusted for inflation each year, once you begin to draw from it? Is the benefit defined or a % amount?

The answer here depends on these questions, along with how long it would take to recover your tax hit.
Last edited by mrspock on Wed Nov 24, 2021 1:53 pm, edited 1 time in total.
Silk McCue
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Re: Any reason not to take a pre-retirement pension lump sum payout?

Post by Silk McCue »

Any possibility the pension could be rolled over to a tax deferred account?

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sergeant
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Re: Any reason not to take a pre-retirement pension lump sum payout?

Post by sergeant »

Why would you want to pay taxes on the lump sum? Just do a rollover to an IRA.
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exodusNH
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Re: Any reason not to take a pre-retirement pension lump sum payout?

Post by exodusNH »

gophermobile wrote: Wed Nov 24, 2021 1:47 pm I am 39 years old and married, and recently left a company that had a pension. It's not a huge amount - valued at about $68k currently. With their calculator, it says it will be worth around $178k by an official retirement age (65) which is less than 5% yearly growth.

I don't need the money now, but I would rather have control over it as I think I can earn a better return instead of letting it sit with the company for the next 20+ years. If I take the lump-sum payment now, I would need to pay taxes which would total around 30-34% for state + federal.

I am planning to retire early, possibly within next 5-10 years, so my taxes may go down though I don't think drastically. Overall my net worth is about 2 million, with 2/3rds in retirement accounts (401ks, ROTH IRAs). Another advantage I see is that this would shift some additional money out of retirement accounts and make it more accessible as I get closer to FIRE.

So...any good reason not to take the lump sum payout now and invest it on my own?
While 5% doesn't sound good, that's a decent return for fixed income, especially if the pension is guaranteed. You could consider this to be your bond allocation and use the rest of your accounts for equities.

Can you decide to pull the funds at a later date, or is this a decision you have to make shortly?

Rather than recognize this $68K of income, might you be able to put away an additional $7K-$15K/year into a taxable account, even if that reduces your 401k contributions? That might be a more tax-efficient way than taking the big hit all at once. It depends on your marginal tax rate.

If you've managed to save nearly $1M in your 401k at only 39, I assume that you're paid pretty well. That $68K might also push you into NIIT bracket, which is another 3.8% tax.
NoProbLlama
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Re: Any reason not to take a pre-retirement pension lump sum payout?

Post by NoProbLlama »

Biggest benefit to the pension payments would be as a potential hedge against longevity risk. So it's really a question of Lump Sum now versus a guaranteed lifetime payment in the future. The 'value' of that benefit varies by many factors (see mrspock's questions). It may also be helpful to inquire with the plan administrator at the previous employer to get the details of how they calculate the lump sum amount. Many plans have interest rates that reset at regular intervals, and many of those are historically low rates right now (resulting in inflated Lump Sum quotes).

Sounds like it's gonna be a be a small fraction of the overall scheme in your particular case. This may come down to what fits your preferences for overall ease/complexity, rather than the nuts/bolts of optimizing each dollar.
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JoeRetire
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Re: Any reason not to take a pre-retirement pension lump sum payout?

Post by JoeRetire »

gophermobile wrote: Wed Nov 24, 2021 1:47 pm I am 39 years old and married, and recently left a company that had a pension. It's not a huge amount - valued at about $68k currently. With their calculator, it says it will be worth around $178k by an official retirement age (65) which is less than 5% yearly growth.

I don't need the money now, but I would rather have control over it as I think I can earn a better return instead of letting it sit with the company for the next 20+ years. If I take the lump-sum payment now, I would need to pay taxes which would total around 30-34% for state + federal.

I am planning to retire early, possibly within next 5-10 years, so my taxes may go down though I don't think drastically. Overall my net worth is about 2 million, with 2/3rds in retirement accounts (401ks, ROTH IRAs). Another advantage I see is that this would shift some additional money out of retirement accounts and make it more accessible as I get closer to FIRE.

So...any good reason not to take the lump sum payout now and invest it on my own?
Is this a decision that has to be made now?

Personally, I think guaranteed, 5% growth is pretty attractive these days. And I tend to prefer paying taxes later, rather than now.

That said, the amount is pretty minimal at this point. Not a huge deal either way. Do whatever brings you the most joy.
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gophermobile
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Re: Any reason not to take a pre-retirement pension lump sum payout?

Post by gophermobile »

A few answers to questions:
  • I don't have to do anything right now, I can do this at a later date
  • Yes the plan can be rolled over to a 401k / IRA (or at least I saw that option), but I would think I'd need to pay taxes on that as well? Have not looked at it fully yet
For mrspock's questions, I'm having trouble finding out whether it's a defined benefit or % amount. The plan document states it's a "qualified defined benefit plan also known as a cash balance pension plan" if that answers it? As far as the adjustment for inflation, I see this "These limits may be adjusted periodically for changes in the cost of living and may be adjusted depending on the form of benefit you select and date you start receiving benefits" but not sure if that answers it directly.

Also to update, the lump-sum payment at 55 would be $122k lump sum, $538/month single life annuity, $533/month life w/10 year certain
At 65: $173k lump sum, $1,196/month single life annuity, $1,156/month life w/10 year certain

Also does a pension like this depend on the solvency of the underlying company? This pension is from a large aerospace company that has not been doing particularly great lately. Not that I would expect them to pull an Enron, but their future state is murky.
NoProbLlama
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Re: Any reason not to take a pre-retirement pension lump sum payout?

Post by NoProbLlama »

gophermobile wrote: Wed Nov 24, 2021 2:50 pm Also does a pension like this depend on the solvency of the underlying company? This pension is from a large aerospace company that has not been doing particularly great lately. Not that I would expect them to pull an Enron, but their future state is murky.
Your plan is most likely covered by the PBGC (Pension Benefit Guaranty Corporation), which is a government-backed organization that would step in to cover benefits (up to a limit, which won't be a factor for your case) if the underlying company became insolvent.

Your SPD should indicate if the plan is covered by PBGC. There's also a search tool online at: https://www.pbgc.gov/search-insured-plans
psy1
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Re: Any reason not to take a pre-retirement pension lump sum payout?

Post by psy1 »

I personally don't like my money being tied to the well-being of a company in the distant future. Who knows how well the pension is funded anyway? Were it me, I would take the option to roll the lump sum over into a tax deferred account like an IRA. That way you can control your own money with low fees. I also don't like they way they describe the inflation adjustments in such a way that you have no idea whether there is a periodic inflation adjustment.
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Re: Any reason not to take a pre-retirement pension lump sum payout?

Post by 123 »

If the pension lump sum alternative is based on a series of IRS established interest rates (many pensions offered by private companies use these rates) now is a very good time to get a lump sum payout because interest rates are low. If the pension lump sum is based on the IRS established interest rates normally the formal calculation you receive will identify the specific rates involved. If the IRS rates are used it is quite possible for the lump sum alternative amount to go down considerably if interest rates rise. So even though the potential monthly benefit may go up due to your age the lump sum alternatives can go in a different direction due to higher interest rates.
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