Details to Consider About Each Option:
TAKING THE PENSION AS A LUMP SUM ROLLOVER:
A lump sum rolled tax-free into an IRA allows you to control the assets and invest them independently (or use a financial advisor to invest them). This choice has many advantages, including the ability to adapt to future market conditions, the opportunity to grow the account to keep pace with inflation, and the option to leave funds to create a legacy for your children. On the other hand, this choice does expose you to more risk as the markets ebb and flow.
TAKING THE PENSION AS AN ANNUITY:
If you choose to take your pension as an annuity, you have the advantage of a fixed monthly income over your lifetime without market fluctuations. There are several disadvantages as well, namely in the form of inflation. As the years go by, your payment amount will not change, meaning your purchasing power will erode as cost of living increases. Also, once you die, there is usually nothing left to leave as an inheritance for your children.
Another factor that enters into the decision-making process with these two options is the current state of interest rates in the market. If you take a lump sum payout, then the amount that is rolled over is the balance in your account. If you choose the annuity, then the actual monthly amount depends on the interest rate used to calculate the stream of income over your life.
In addition to the advantages and disadvantages of the two options, you should consider the tax impact as well. In a lump sum rollover into an IRA, you will not pay any taxes on the rollover. However, once you reach age 70 ½, you must take Required Minimum Distributions (RMDs) that are taxable. On the other hand, taking the annuity option means you have no ability to alter your payout strategy for tax purposes, however, you are not subject to the RMD rules at age 70 ½.
How Annuity Benefit Calculations and Hybrid Annuity / Rollover Options Work:
ANNUITY BENEFIT CALCULATIONS:
The pension plan provides that the interest rate is set by using the 3 tiered corporate bond rates published monthly by the IRS. There are two dates that are important in making decision, August 31st and December 31st. For example, if you retired on July 1st, the interest rate used to calculate your monthly annuity payment would be the IRS rate for August of the previous year.
There is a window between September 1, and December 31, where you will know the rates for both years and can choose the higher one to maximize your benefit. Once you start receiving your annuity payments, the payment remains unchanged for the rest of your annuity. The higher the IRS rate, the higher your monthly payment will be for your lifetime. Thus, it is important to pick the right year to begin receiving your pension annuity. We might recommend that you wait until early September to decide which year to start your annuity.
HYBRID ANNUITY / ROLLOVER OPTION
To further complicate matters, you also have the option of taking part of the account as a lump sum rollover and part as an annuity. This hybrid plan could make sense if you only wanted to cover your basic living expenses with an annuity and invest the rest for the discretionary purchases.