What should I do with my pension from a former employer?
I am 54 years old and I'm contributing to a company 401(k) plan currently. A former employer has offered me a limited amount of time to pay out or roll over a pension benefit to vested participants. I have only $18,000 in the account. I could keep it in their plan to begin payments at 65 or roll it over in an IRA. Would the Roth IRA or a regular IRA be more beneficial?
It reads like your pension is a defined benefit pension plan, and at the low levels of interest rates we are currently experiencing, it may be a good opportunity for you. It could simplify your financial affairs a little, and even though the $18,000 is a relatively small amount, which translates into a modest amount of monthly income, there are many things to consider.
There are pros and cons to each approach. The pension benefit would offer a fixed and stable income amount but may or may not be adjusted for inflation and would be fully taxable assuming the contributions were not taxed. If you roll the funds into a Roth IRA - it can be very effective because all withdrawals are tax-free. Also you heirs can inherit the IRA and stretch out tax - free withdrawals over their entire lifetimes if they choose to. However, if the original contributions were pre-tax you would need to pay all of the taxes currently upon conversion. These decisions are best made in the context of a big picture comprehensive financial plan.
You can roll over into a traditional IRA without paying any taxes now and will not be required to take minimum distributions until you reach the age of 70 1/2. At which time you will be required to take a minimum distribution each year thereafter which will be considered and taxed as ordinary income.
Choosing the ROTH IRA option, you will have to pay oridinary income tax on the entire balance for the tax year you roll over. If you elect to take the taxes from the balance, obviously your balance will be much smaller and therefore tax free growth of a smaller amount. You can elect to pay those taxes from monies you have elsewhere if that is an option. The ROTH IRA option does make you pay the taxes upfront, but allows you to avoid the Required Minimum Distribution later.
Its an either or. Pay taxes now and avoid being required to take money our and pay taxes later with the ROTH, or postpone paying taxes until later and be required to take a percentage out later with the traditional IRA.
Rolling your former employers 401(k) over to a traditional IRA is, most likely, the simplest and most effective choice. However, without more detailed information about your current financial position a precise answer cannot be given.
I'll first focus on the pro's and cons of rolling it ionto an IRA, then I'll address the Roth vs Traditional IRA decision.
Pro's of rolling over:
You may be able to gain access to many more investment options and have more control over your retirement account. Some 401k plans may have high-cost investment options (expense ratio's of the funds), so rolling funds into an IRA may lower your costs if you can reinvest in low-cost exchange traded funds. Many people have had multiple jobs, which leads to the frustration of having multiple accounts at different places. We've found that most of our clients are more satisfied knowing that all of their retirement accounts are in the same place.
Con's of rolling over:
I mentioned that some 401k plans may be a little more costly, but overall, 401k plans usually have lower fees because of how large they are. 401k plans may have access to institutional-class funds, which tend to have lower fees. If you plan to retire earlier, or later, there may be more flexible options for withdrawing money from your 401k than an IRA would allow.
If you decide that it makes sense to roll your old 401k account into and IRA, then what type of IRA should you use? That will depend mostly on your tax bracket now vs when you retire. If you will be in a higher tax bracket when you retire than you are now, then a Roth IRA makes more sense. Pay the lower tax on the $18,000 now and you wont have to worry about being taxed when you take your withdrawals or RMDs. If you will be in a lower tax bracket when you retire (this is more common) than you are now, rolling your 401k into a Traditional IRA would make the most sense, because you avoid taxes until you start your withdrawals at retirement.