Should I Take a Partial Lump Sum Distribution?
With Teacher Appreciation Week a month away and veteran school teachers looking to retire at the end of the school year, the one commonly asked question before they take off and ride into the sunset is, "Should I take a partial lump sum distribution?" In order to answer the question, there are a few things to look at.
How Much Can I Take?
Generally speaking, up to 36 months of your retirement annuity. If you do not need 3 years of your annuity fronted to you, there are other options available to you; usually 12 and 24 months of your annuity payment. Like every retirement plan, if you take money up front, it comes with consequences.
What Happens to My TRS Annuity Benefit?
It gets reduced. The exact words on the TRS Website is "actuarially reduced." What is the difference? Reduced vs. Actuarially Reduced. Well, in as much plain English as I can put it, there are more factors taken into consideration than just the amount you take from your benefit; for example, how likely you are to live a long life. In an actuarial calculation they take everyone who is similar to you (i.e. weight, age, gender, work, etc..), and they are betting some people pass away early to make up for the people that live a long life. So after they pay you upfront, you should expect the reduction to your pension benefit to be more than just your distribution divided into the years they expect you to live.
Do I Get Taxed On That Money?
Of course you do! That money was put into your TRS account pre-tax. So when you take it out, naturally it will get taxed. Gotta love Uncle Sam. The real question is When will you get taxed? If you take the partial lump-sum distribution and put it into your checking account, then you will be taxed that year as if you earned the money. However, if you roll it over into a tax-deferred account like an Individual Retirement Account (IRA), then you won't be taxed until you draw from it.
Should I Put My Distribution In My Checking Account Or An IRA?
Typically, if someone puts their distribution into a checking account, they are ready to use it. I am an advocate for making prudent decisions. If you are looking to splurge on a vacation to celebrate retirement, a new car, etc... I would caution you to compare the cost of this decision (i.e tax and long-term reduction of your benefit) vs. the length of time the expense will make you happy. It may seem justified in the short-run but not so much in the long-run.
Rolling over your partial lump-sum distribution into an IRA may seem like a legitimately reasonable thing to do as well. You do not get taxed up front. You get the flexibility to take out money freely thereafter. And most importantly, it has the potential to grow with the stock market, or not...There will always be risk in investing but the real question is, are you willing to take risk with guaranteed money?
What Else Should I Consider?
I would say the expected return on investment. If you decide to take a distribution from your TRS benefit to roll over into an IRA, finding out what kind of return you would need from the stock market to make up for the reduction in benefit is important.
Every teacher is different so every situation is different. There are plenty more moving parts when it comes to making an irreversible decision such as this one. Your spouse, kids, and other personal financial goals should be taken into account. It helps to run this kind of decision by a Certified Financial Planner™ familiar with the Teacher Retirement System. Don't know where to look for one. Check out the Financial Planning Association's PlannerSearch tool to find the nearest one to you.
MyLife Financial is a fee-only financial advisory firm providing objective and independent advice virtually. Our clients are busy professionals that face daunting questions of how today's financial decisions will affect their long-term financial success. Everything written is strictly for informational use only. Please seek the advice of your CPA, Attorney, or financial professional before implementing any strategies.
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