There are many factors to consider when deciding the best way to take your retirement distributions.
- Cash flow needs;
- Projections of wealth accumulation—comparison of alternative scenarios such as: annuity payout, lump-sum distribution, traditional IRA rollover with maximum tax deferral, conversion of traditional IRA to Roth IRA;
- Your ability to manage a large sum of money;
- Your life expectancy;
- Your and your spouse's health;
- Who will be relying on your retirement assets?
- How will your retirement income and other cash sources be taxed?
To help you plan and avoid some costly mistakes, consider the following questions:
- How comfortable are you managing your own money? Do you want to be responsible for making sure you have an adequate income for the rest of your life? If you're not an investor, plan to take the annuity or, if you prefer a lump-sum distribution, plan on hiring an investment manager.
- When will you need the money? If you have both a defined benefit plan and a defined contribution plan and don't need all the income at once, consider taking an annuity payout from your defined benefit plan and let your money grow tax-deferred in the defined contribution plan.
- What other income sources will you have? If your only other source of income is Social Security and you're not comfortable with investing, consider taking the annuity. Leave the burden of making your retirement income last for a lifetime with your company. Social Security has cost of living increases to help you offset the eroding effect inflation will have on your fixed monthly income.
- How is your health? If you have a strong indication that you might not live very long and no one depends on you for income, plan on taking the lump-sum distribution.
- Will others (assuming you're not married) be dependent on your income? You may have a parent or child that is financially dependent on you. You may want to consider a period certain annuity, naming one of them as your designated beneficiary. Although you may have to get by on less, you have the comfort of knowing an income will continue to your beneficiary if you die while he or she still needs financial support. Your monthly check won't be as big as if you elected the single life annuity, so consider saving more now.
- Will your spouse need the income if you die? You'll have to ask yourself some more questions to answer this one. Does your spouse have his or her own pension plan? What will his or her projected Social Security benefit be? How much life insurance do you and your spouse have, and will you be keeping it for your lifetime? What other income-producing assets will you have? How long will your spouse need the income? Consider the joint and survivor annuity if your spouse will need the money. A 100% joint and survivor annuity will provide your spouse with the most income upon your death, but your monthly check will be lower than if you choose a 50% joint and survivor annuity. Make sure that your retirement planning takes into consideration the possibility of each of you predeceasing the other.
Your employer should be able to provide you with estimated payout projections of the various annuity options.
After considering all of the factors when making your distribution choice, you should then determine the most effective way of taking your distribution from your retirement plans, giving attention to minimizing income taxes and excise taxes. A choice on the optimal form of retirement benefits to be received can be objectively determined based on the after-tax monthly retirement income that each option will provide, given your expected marginal income tax rate in retirement, the rate of return that can be earned on your retirement funds, the expected benefit payout period, and the balance in the qualified plan account at retirement.
But these mechanical computations must be considered with non-tax issues, such as your ability to manage large sums of cash, the possibility of you outliving the assets, and what your thoughts are on your life expectancy. Your overriding consideration is to remember that this money must last you a lifetime - and it may be a much longer lifetime than you expect. An annuity in most cases pays a benefit for your lifetime (so you can't outlive your capital). However, if you die prior to your life expectancy, you and your beneficiary, if applicable, may not collect the full value of your accrued benefit. With a lump-sum distribution, you manage the money, and may outperform the annuity. You can also continue to defer taxes by rolling the money into a traditional IRA. You may also be able to take advantage of tax-free growth by converting to a Roth IRA. However, if you don't properly manage your money, it may not last as long as you need it to.
Your financial professional can help you clarify how to use the different payout calculations in your retirement planning and discuss with you the considerations involved in selecting a distribution option.