- Michael DiBartolomeo
Can I Convert My Pension to Cash?
When nearing retirement, people should consider what the best option for them is going forward. After all, their entire work history will directly affect the size and frequency of their pension. And just like many other aspects of handling finances, figuring out the best pension plan is never easy.
Nowadays, a lot of workers are considering going with a somewhat safe method of regular pension payment. After all, a monthly annuity payment that comes every month until the recipient passes away seems like the perfect solution. However, there’s also an option of getting a lump-sum payout. So, how exactly can a retired individual convert their pension into cash? This article is here to help them find out.
Regular Pension Payments
As its name suggests, a regular pension payment is one that happens each month. Usually, the monthly sum is determined based on a few factors:
● The employee’s salary
● Their years of employment
● Current interest rates
● The dollar value of the monthly benefit
● Cost of living adjustments (COLA)
● The calculation method chosen.
Once a monthly payment sum is determined, it stays relatively the same after the person turns 65 and retires. Any potential changes to this amount will have to do with the current value of the dollar, inflation rates, etc. But other than that, the sum will not significantly change.
One potential flaw of this arrangement is that the recipient will not be able to receive or withdraw more money in case they need it. Once a sum is set, it stays the way it is. In other words, recipients have to carefully manage their living expenses based on this sum and avoid any frivolous spending or major investments.
However, there are plenty of benefits to having regular pension payments. First and foremost, they will literally roll out every month until the day the recipient passes away. Moreover, in certain cases, a living spouse can still receive the pension from their deceased recipient. But an important aspect to consider is health insurance coverage. There are more than a few companies that will refuse health coverage if a person decides to take a lump sum payout. People would then have to include the extra cost of private health insurance in their calculations.
Lump-sum Cash Payouts
While a regular pension is definitely more stable, it does have some shortcomings that a lump-sum payout can handle. Lump-sum payments are one-time payouts from pension administrators. They offer the recipient a large sum of money at once which they can use any way they see fit. They can spend it at once or make different investments that might provide passive income.
The best part about a lump-sum cash payout is the immediacy of the funds. For example, if a person has to cover sudden medical expenses, this method of withdrawing money can help them out. Moreover, by depositing said sum in a bank, they can name a beneficiary to receive the money once they are no longer alive.
Of course, taking income from pensions is susceptible to taxation. The recipient can handle this issue by rolling the lump sum over into their IRA and gaining more control over fund removal and paying the income tax on it. Once the recipient turns 72, they will have to take the required minimum distributions from their IRA.
However, lump sums have some major setbacks. The biggest one is definitely the risk of running out of money. By taking a large lump sum early on, the recipient will receive a fraction of their regular monthly payout. Quite a few pensioners mishandle the lump sum and end up outliving their earnings.
Additionally, there is an option to cancel a pension and get the money from it, if it is extremely necessary.
A cash-balance plan is similar to a regular pension, but with a few key differences. The recipients also get a set payout every month. However, the amount they receive will differ from a regular pension. Namely, this plan credits the employee's account with a set percentage from their salary each year, from 5% upwards. Once that’s done, the employee gets a statement each year that shows them:
● What their hypothetical account’s value is
● What sort of monthly income they can expect when they retire at 65
Another key difference between a cash-balance plan and a regular pension plan is that it’s portable. In other words, the recipient does not lose money if they leave the company before retirement age. Instead, they can take the contents of the plan and then roll it as a lump sum into their IRA.
Interestingly, an employer can actually convert a traditional pension plan into a cash-balance plan. This conversion was used by employers in the US in order to reduce their pension obligations to their employers. That all changed thanks to the 2006 Pension Protection Act. According to this document, a worker cannot receive benefits that are lower than what they were entitled to before the plan conversion.
Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax, legal, or investment related advice. We suggest that you discuss your specific situation with a qualified tax or financial advisor. Historical returns are no indication of future returns in any given asset class.
This material was prepared for The Kelley Financial Group.