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Two Factors to Consider for Annuity vs Lump Sum
Old 06-29-2013, 09:32 AM   #1
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Two Factors to Consider for Annuity vs Lump Sum

One factor to consider in deciding between a lump sum and annuity for a pension, which I haven't seen mentioned elsewhere in this forum, is that pension income is subject to state income tax in some states, but not in others. In Illinois, for example, pension income is not subject to the 5% state income tax, but IRA withdrawals are taxable at that rate.

This means that when deciding between taking a lump sum and rolling it into an IRA, or taking a monthly payment, an Illinois resident should subtract 5% from the lump sum amount when doing the math to decide between the two options, whereas someone who lives in a state where pension income is taxable would not make this adjustment. For someone in Illinois, this swings the pendulum somewhat in the direction of taking the annuity.

But for younger ERs, another factor, PBGC limits, may swing the pendulum in the other direction. The PBGC limit is based on the pension recipient's age at the time the company holding the pension goes bankrupt, and the limit increases with age. In my case (age 52) the limit is about 300 dollars per month less than the monthly pension amount I will receive when I retire soon. My break-even point is age 56 - if my company goes bankrupt any time after that, I will be guaranteed my full pension amount.

In my case, although it's certainly possible that my company will go bankrupt at some point, it's much more likely to happen a few years down the road than next year or the year after, so I feel like the state tax break outweighs the risk of a low PBGC payment.

Now somebody please correct me if I've missed anything or (even worse) mis-interpreted something.
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Old 06-29-2013, 09:50 AM   #2
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Are you sure TIRA withdrawals are taxable in Illinois?
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Old 06-29-2013, 10:15 AM   #3
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Are you sure TIRA withdrawals are taxable in Illinois?
+1

Turbotax says they're not, and that's how my mother's taxes have been filed all these years.
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Old 06-29-2013, 10:22 AM   #4
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+1

Turbotax says they're not, and that's how my mother's taxes have been filed all these years.
I'm glad I added the "now please correct me..." at the end of the thread.

I was not aware of that, and must have missed something while investigating. I wonder if that's true in every state - pension income is taxable if and only if TIRA withdrawals are taxable?
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Old 06-29-2013, 10:58 AM   #5
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This is also an issue in Maryland. Maryland allows a limited exemption of pension income once you reach 65. 401(k) plans are considered qualified pension plans whereas IRAs are not. If you roll your 401(k) to an IRA you lose the ability to use the distributions when calculating the pension exemption in MD.

I do taxes for seniors. I've seen many cases where people have rolled pensions and 401s into IRAs and lost the entire pension exemption.
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Old 06-29-2013, 02:07 PM   #6
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I understand you might not qualify for un employment if laid off / early out / RIF etc.. and you take the annuity, but do qualify if you leave it in the pension or Roll over into an IRA.
Is this the case?
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Old 06-29-2013, 02:16 PM   #7
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I understand you might not qualify for un employment if laid off / early out / RIF etc.. and you take the annuity, but do qualify if you leave it in the pension or Roll over into an IRA.
Is this the case?
This varies from state to state. Don't try to hypothesize a general rule. You need to refer to the unemployment web site for each state to find out what the rules are there. In Illinois, pension benefits offset unemployment benefits dollar for dollar unless you can show the pension is from employment which occurred prior to the employment for which you applying for benefits. SS offsets dollar for dollar in Illinois too. But, in some states, SS benefits do not offset unemployment benefits.

Again, look it up state by state. Don't try to guess a general rule.
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Old 06-29-2013, 02:19 PM   #8
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I'm glad I added the "now please correct me..." at the end of the thread.

I was not aware of that, and must have missed something while investigating. I wonder if that's true in every state - pension income is taxable if and only if TIRA withdrawals are taxable?
It is not true in every state and no generalization is possible. Look up the situation for the state you're interested in.
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Old 06-29-2013, 02:22 PM   #9
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+1

Turbotax says they're not, and that's how my mother's taxes have been filed all these years.
I dug into the situation in Illinois in regard to Roth conversions. Pensions, TIRA withdrawals, Roth conversions, all non-taxable in Illinois.
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Old 06-29-2013, 02:26 PM   #10
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It is not true in every state and no generalization is possible. Look up the situation for the state you're interested in.
+1


Quote:
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I dug into the situation in Illinois in regard to Roth conversions. Pensions, TIRA withdrawals, Roth conversions, all non-taxable in Illinois.
That's good because I think beginning this year her deductions will be high enough to allow some Roth conversions in my mother's account.
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Old 06-29-2013, 04:23 PM   #11
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It certainly varies by every state. Pension incomes aren't taxable in Hawaii, nor are the employer contributions to a 401K even if rolled over IRA or taken as a lump sum.
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Old 06-29-2013, 08:05 PM   #12
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It is not true in every state and no generalization is possible. Look up the situation for the state you're interested in.
And while it's certainly a factor worthy of consideration - what's true today, may not be true for the duration of one's retirement...
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Old 06-29-2013, 11:27 PM   #13
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And while it's certainly a factor worthy of consideration - what's true today, may not be true for the duration of one's retirement...
+1

Michigan's new governor succeeded in changing the laws to make, in my case, the pensions fully taxable where they were fully exempt before.

Given the long time horizon of a pension, you may wish to discount any immediate advantage by the chance that it might not last.

-gauss
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