Lump sum? Monthly payments? IRA? So many questions as I retire: How should I proceed?
Q: I have worked for the same company for over 20 years. When I was hired, there was a defined benefit plan that was discontinued a few years later. HR will require me to decide if I want to take a lump sum or receive a monthly payment. Not only that, but I also have been buying my company’s stock at a discount in my defined contribution plan; it is up tenfold. Should I roll my retirement account into an IRA or leave it with the company? Unfortunately, my current plan has very few investment options, and they are mostly target-date funds. Any suggestions?
A: Congratulations on a long career with a successful company that has been able to grow the stock price while offering employees excellent benefits. Now you must make wise choices that are very personal to your goals and family dynamics.
Start by requesting the details on your defined benefit plan. Compare the monthly payments to the lump sum payout. Estimate your longevity; it’s all about your health and genetics. Now, modify it for lifestyle habits, too. Do the math using net present value calculations and you will have your textbook answer to this important, irrevocable decision.
But wait, before you pull the trigger, ask yourself if you would prefer to have options. Are you happier when you are in control? Is there a Tennessee mountain cabin in your future? Real estate appreciates at about the same average annual rate as stocks do, without the stress of 4 p.m. market updates. Would you prefer to take the lump sum and invest in a property that can provide more fun? Taxes matter, so always factor in ordinary income tax on retirement distributions. Timing is everything, and a mortgage on the Tennessee cabin might make tax sense, not to mention the leverage.
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Now, let’s review your IRA rollover options. Obviously, it’s easier to change beneficiaries, take distributions and diversify an IRA account when you have control. Third-party administrators often have minimum withholding rules and administrative delays. Fund options are often limited, and in 2022, target-date funds that were thought to be positioned conservatively saw large declines as the rise in rates hurt both bond and stock prices. The Vanguard Target Retirement 2025 Fund (VTTVX) fell more than 15% in 2022, despite being close to its target date.
If you contributed to a Supplemental Executive Retirement Plan (SERP) or an Excess Retirement Savings Plan (ERSP) be sure to calculate this additional income which will be paid out at retirement. Your payments will be based on the pre-established distribution time period you selected (ie.3,5,10 years). This income will be taxed as ordinary income.
Before you do anything, review the rules for the tax treatment of employer company stock in a qualified retirement plan.
Net unrealized appreciation (NUA) allows a transfer of employer company stock from a retirement account into an after-tax account (not a rollover IRA) and paying ordinary income tax on only the cost basis of the shares. NUA rules allow the participant to move specific shares, and choosing only the lower-cost-basis shares is the most advantageous tax strategy.
The company retirement plan administrator tracks the cost of the employer stock and reports the basis to the IRS in the year of the transfer to the taxable account. Shares may be held or sold at any time in the taxable account. The difference between the purchase price and the current value is taxed at the favorable long-term capital gains tax. While ordinary income tax rates may be as high as 37%, long-term capital gains tax rates are graduated and range from zero to 15% to 20%.
NUA may be implemented at (or after) termination of employment, or in the event of the employee’s disability or death. The company stock must be transferred as an “in-kind lump-sum distribution” in a single calendar year. If you roll your company stock into an IRA, you missed the opportunity to use this useful and somewhat complicated tax strategy. Measure twice, cut once. And most of all, work with experienced professionals.
Mary Baldwin, CFP®, is a fee-only financial planner at Buckingham Strategic Wealth in Indian Harbour Beach. Contact her at 321-428-4555 or mbaldwin@buckinghamgroup.com.
For informational and educational purposes only. Individuals should speak with a qualified financial professional based on their own circumstances to determine if the above is appropriate. The opinions expressed by featured authors are their own and may not accurately reflect those of Buckingham Strategic Wealth® R-23-6352
This article originally appeared on Florida Today: Separation anxiety: What financial questions should I ask as I retire?
