06 Aug 2014 Should You Rollover Your Pension into an IRA?

We all want to make smart choices. Whether the choice is Honda vs. Toyota, who we marry, or where we send our children to school, we spend time and energy making the wisest decisions we can.

Our finances are no different. We face all sorts of important financial decisions during our lifetime, and the decision I’d like to focus on today is this: Should you or should you not roll your pension into an IRA when you retire? To be clear, I’m not talking about your 401(k), where the decision to move the balance to an IRA is a bit more straightforward. No, I’m talking about the pension plan that your employer maintained for you, in which your options are either to roll a lump sum payout into an IRA tax free, or to take a lifetime income based on your life expectancy (or the combined life expectancy of you and your spouse).

Choosing the fate of your employer pension plan proceeds may not seem like a big deal, but the decision you make could have a dramatic impact on your lifestyle in retirement, so it’s important that you make an informed one. The answer to our question can best be found only through the creation of a financial plan that measures the impact each choice would have on our ability to live the life we want, with as little worry as possible. However, while the decision is certainly an individual one, there are some general guidelines we can use to help.

Lump Sum Payout. At a high level, the lump sum payout option has several positive characteristics:

• You retain control over how you invest and draw income from your money.
• When you pass away, you are able to leave whatever is left to your kids or your favorite charitable organization.
• You have the freedom to roll the money over to an IRA initially, and then decide later on to purchase a lifetime income from another insurance company.
• You can invest in a portfolio that is designed to provide you with income that is adjusted for inflation

Given the above, it oftentimes makes sense to roll your lump sum pension benefit over into an IRA, but only if you do so wisely. There are some things to consider before you do:

• Don’t invest the proceeds in an expensive annuity (variable, fixed or index) where much of the benefit of transferring the funds is eaten up with high fees and commissions. Why would you trade a guaranteed lifetime income for an expensive product which is designed to provide you with a guaranteed lifetime income?
• Consider your risk tolerance. If your tendency is to move your money to cash each time the S&P 500 falls more than a few percent, perhaps you would be better off with the income benefit.
• Be careful not to move the lump sum to your IRA only to invest the proceeds in an investment mix that is too conservative, and may not keep pace with inflation. Instead, invest the proceeds in an efficient, diversified portfolio with only the amount of risk necessary for you to keep up with inflation and accomplish the things that are most important to you.
• Make sure to have a plan.  One that you review often to ensure that your income will last as long as you, or you and your spouse do.
• If you work with a financial advisor, make sure you know how they are paid and if there are any conflicts of interest.

Lifetime Income. So there we have the lump sum payout option. The other option, the draw of a lifetime income benefit from the pension plan, has its own benefits:

• Depending on the election you make, the income you receive generally is guaranteed to last as long as you (or you and your spouse) do.
• Some pensions offer a cost of living adjustment, so your income will increase as inflation does.
• The income you receive is not affected by the ups and downs of the stock market.

However, just as we saw with the lump sum option, there are some things to consider when thinking about a lifetime income:

• How is your health? If your life expectancy is shorter than average, it may not make sense to take a benefit that is based on normal actuarial tables.
• Make sure that your benefit has a cost of living adjustment so your income will keep up with inflation.
• Make sure you are considering your spouse. What happens to your payout in the event that something happens to you?
• If you are choosing this benefit, then you should have a long life expectancy—so would delaying the benefit make sense?
• Check the financial health of the company issuing the payout (hint: it may not be your employer). While your income may not be subject to stock market fluctuations, it can be impacted if something happens to the company guaranteeing your benefit.
• Do you have other assets that can satisfy your desire to leave a legacy?
• Interest rates are at historic lows. Since annuity payouts are tied to interest rates, taking a lifetime benefit could mean locking in a lower payment amount.
• Is the lifetime income a good deal? Are there alternative lifetime income options that are better?
• Speaking of good deals, before you take a lifetime benefit, ensure that you maximize your Social Security benefit—another guaranteed lifetime income.

Ultimately, the decision of whether or not to rollover your pension plan into an IRA is a complex, individual one. Make sure that you are making an educated decision that takes into account your goals for the future, your spouse, your desired legacy, and your entire financial picture.  A wise decision will allow you to do more of the things that are most important to you, whether that’s retiring earlier, leaving more to charity or the kids, or sleeping well at night.

If you have questions get some advice.  Preferably from an independent financial advisor.