We were recently told that our defined benefits plan was being taken away. For those that are confused, a defined benefits plan is what is normally called a pension. For me, I haven’t been around long enough for it to really affect me. Some, who have been around for a very long time and are nearing retirement, it will mean a rather significant chunk of the money that they thought they would have for retirement will be gone. To their credit, our employer is doing it the right way.
Rather than just declaring the fund bankrupt, or letting it run until it was bankrupt, they’ve decided to shut it down gracefully. What that means is that those of us who are vested in the plan will receive a payout of the amount we have vested. And, as part of that, we need to decide what to do with that money. We have four options:
- Buy an Annuity. Annuities basically work like this: You give them a lump sum of money, and they agree to pay you a monthly amount back. The total of the payments is equal to some amount greater than the amount that you gave them. It’s usually based on current interest rates.
- Roll the money into the company 401(k). I’m already participating in the 401(k), so this would be a logical place to go with it.
- Roll the money into an IRA. Also a logical way to use the money. Could be rolled over into a Roth IRA as well. Either way, I have far more control of the money than I would in my 401(k). Also, I don’t believe I’d have to worry about IRA Contribution Limits if I roll it over.
- Take a cash payout. They’d just write me a check, minus the 10% early withdrawal penalty from the IRS.
I’ve ruled out option 1 as it doesn’t make any sense to do with the interest rates where they are. Most likely, I’ll be using option 2. But, I just can’t come to a concrete solution. If I take option 2, I add a significant amount of money to my 401(k). More is always better. But, I have no more control of that money than I do with the current money that’s in there. If I take option 3, I still retain the same amount of money in a retirement account, plus I have far more control of where the money is invested than I do in the 401(k). That’s also the con of this option though. I’m no investment expert. I could look to invest in a stocks and shares ISA but as a general rule, most of the investments I’ve made aren’t all that great. Which means it would have to be limited to EFTs and Mutuals which doesn’t afford that much more control than in the 401(k). The final option would be to take the money in a check. The big downside there is that the IRS takes 10% off the top as a penalty. Then, it’s counted as income which gets taxed as income. In our tax bracket, that could mean an extra 15% in tax liability. If it bumps us up into a new bracket, it could mean some of it could be 25% in tax liability. So, I’d pay an instant (or nearly so) 25-35% if I took a check. But, that still means I would receive a lump sum of several thousand dollars. That money could be used to pay off at least one credit card, if not two, and alleviate some of the monthly burden that our debt gives us.
I know that the safest (rightest) answer is to put it into one of the retirement accounts, but having the cash to dump some of our debt would also be very advantageous.
What would you do? If you were in my situation, would you play it safe and roll the money into your 401(k)? Would you take the cash and pay something off to reduce your monthly expenses? Tell me how you would handle this!