If you have a pension or a retirement savings plan where you work and income from that source is a mainstay of your budget, the ideal solution is to have your first retirement payment arrive the month after you receive your last paycheck.
On the other hand, if you do not need the money right away, then your goal is to determine the best way to continue to take advantage of the potential for tax-deferred growth. Most plans offer a number of alternatives and it’s smart to investigate your options.
The Critical Factors
Factors that you should consider when thinking about retirement include your age and health, what you want to provide for your family and other sources of income. A retirement calculator could be helpful to estimate how much you should be saving in order to enjoy the standard of living you want when you retire.
When you retire from an organization that provides a traditional pension, you generally have two income choices - a pension annuity or a lump sum distribution.
With an annuity, you receive income each month for the rest of your life or your life and the life of another person, usually but not necessarily your spouse. At the time you retire, your employer calculates the amount you’ll receive based on a number of factors including your age, your final salary, and the number of years you’ve worked for the organization. Income taxes are withheld from each check.
If you choose a lump sum, your employer calculates the amount you’ll receive and transfers the money to an account you designate. If it’s a cash account, income taxes are withheld, whether or not you plan to move the money into an IRA. If you roll over the amount directly to a tax-deferred IRA, income taxes are not due until you withdraw from that account.
Defined Contribution Plans
If you’re part of a defined contribution plan, such as a 401(k), 403(b), 457 or thrift savings plan (TSP), you have several choices for handling your plan assets. They include the following:
- Leaving your money in the plan, where you may be able to convert it to a pension annuity or take systematic withdrawals.
- Rolling over to an IRA.
- Taking a lump sum.
Unlike a defined benefit pension, which pays your retirement income out of your employer’s pension fund, retirement income from a defined contribution plan comes from assets held in your name. What you receive depends on how much was invested, how long it was invested and how the investments performed. Generally, the assets that have accumulated are sold at the time you choose an income option and the value becomes the principal that is used to purchase an annuity contract, transferred to an IRA or paid out as a lump sum.
A Timing Issue
Before you can begin taking income or roll over your assets, your account has to be valued to determine what it is worth. Every plan values accounts on a regular schedule but no plan does a separate valuation for account holders who want to move their money or begin distributions. In addition, a 401(k) or similar plan has the right to hold your money for up to 60 days after valuation. Not every plan does but this could be the case.
You’re likely to be more confident about making pension decisions if you work with an experienced professional who can answer your questions and help you analyze different routes to your goals. Since many of these choices are irrevocable, you’ll want to weigh the alternatives carefully.
Your employer may have specialists on staff who know the ins and outs of your plan and how other employees have handled the decisions you’re facing. You might ask your other professional advisers for a referral. But don’t feel you have to rush into working with someone. You’ll want to check their professional credentials and resolve to your own satisfaction that the advice you’re being given is both knowledgeable and impartial.