Need advice on how to handle distribution from a terminated defined benefit plan

[Vetralaivas]

My wife and I are both 56 and hope to somehow achieve the dream of a modest and secure early retirement. Together we currently earn about $170K annually.

My wife, a teacher, will be retiring in about 4 years with an annual pension of about $60K. Due to the structure of the teachers retirement system in our state it would not pay for her to work any longer (it actually might hurt) and besides she’s ready.

I’d like to be able to join her as soon as I can.

In about a month, our company’s defined benefit plan will terminate after being frozen for two years. As a result, I will be receiving a lump sum of approximately $750,000. An annuity option is available, but because I qualify for an early retirement subsidy, there wouldn’t have been enough funds in the plan to buy the annuity at today’s interest rates and would have caused a lot of complications with the termination process.

In addition to these resources, I have a small 401K with about $150K.

One of the challenges that we face is the monthly payments we make for consumer debt, probably about a $1000 a month that hampers our ability to save more for retirement and we just don’t seem to be making progress in getting out of the hole. In addition we have a child getting married in the fall and while the couple will be paying for most of the cost of the wedding, we would like to be able to contribute at least $5-6000.

In any event, we are considering taking part of the lump sum , about $40K or so, to pay down the debt and roll the rest into the 401K. I know I will take a tax hit on this, and have earmarked about 30% of the $40K for the tax bill. The 28K or so remaining will go a long way into getting us back on track and out of some high interest debt.

Another strategy I am considering is to take a smaller portion as a partial distribution—say about $20K—roll the rest into the 401K and then take a loan from the 401K to help us eliminate some of the debt. I do understand that the loan from the 401K will have to be paid back, but the immediate tax hit will be much less. The loan payments back to the 401K will still be much less than our current bills and as I understand I will be paying myself back with interest, albeit at a lower rate than I might be able to earn from an investment.

I guess my question is does this plan make sense? If we have any hope of retiring we will need to reduce our debt. Any guidance is greatly appreciated.

 

[chris2008]

Do you already track expenses and know exactly where your money goes each month?
If not, I would start asap.
As next step I would try to modify my today's life style to the level of expenses that gives you a 100% success rate at firecalc http://www.firecalc.com/. It would also be a test for your future retirement income.
Just paying off the debt will not help you on the long run as the debt might reappear soon again.
I'd probably declare the next 2 years as "budget test and preparation years" for retirement and aggressively pay down the consumer debt with what you save.
Such strategy looks better to me than just paying off debt and taking the tax hit.

Make sure that you are on the same page with your wife.

 

[Animorph]

Not sure which way I'd go with the 401k. I think you want to delay any big withdrawals until your income goes down. So maybe the loan, though many don't like that.

But paying off the debt sounds like a must. And along with that is getting a handle on how much you are spending and how that will carry over into retirement, including healthcare expenses. I can see a total income of maybe $96k with what you've described. With a current $170k income plus high interest debt, you may have to cut quite a bit of current spending. That will do a lot more for you than optimizing the 401k withdrawal. Hopefully the withdrawal might even be unnecessary if you can clear 40k off your expenses.

 

[travelover]

You really need to get a handle on your spending. Spending is as important or more important than income in making it all work.

 

[Mulligan]

You really need to get a handle on your spending. Spending is as important or more important than income in making it all work.

I agree Travelover and to all above comments. I would also be curious to what "high interest debt" OP is referring to. Due to my odd nuisances about handling money, I always have debt including mortgage. But all CC debt is 0% and house is 3.75%. In today's interest rate environment a person should not have any high interest debt unless they have bad credit.


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[pb4uski]

Raiding your retirement savings to right your ship is a bad idea. You'll pay taxes and penalties which is a waste.

Roll the $750k into an IRA with Vanguard or Fido.

If you are currently saving for retirement in a 401k or similar vehicle, reduce your contributions to the amount needed to maximize any employer match (or suspend contributions if no employer match) and divert that money to paying down consumer debt.

The issue I have with a 401k loan is if you don't have the discipline to then stay away from consumer debt, then you'll have just dug yourself a bigger hole. Sorry for the tough love, but with $170k of annual income the existence of consumer debt in most cases means that you are living too large.

Also give some thought to building an emergency fund once the consumer debt is gone and as others have suggested, take a hard look at your expenses and budget. Think of it this way, try to fit your lifestyle and expenses to what your resources will be in retirement over the next few years.

 

[Big_Hitter]

how much was the annuity option?

 

[thefinancebuff]

An annuity option is available, but because I qualify for an early retirement subsidy, there wouldn’t have been enough funds in the plan to buy the annuity at today’s interest rates and would have caused a lot of complications with the termination process.

That's not your problem. You want your annuity. Let them figure out what to do.

 

[pb4uski]

OP seems to have been a one post wonder.

 

[Big_Hitter]

you can not be forced to take a single sum distribution over $5K out of a qualified DB plan, regardless of whether the plan is terminating or not

 

[SoClose]

you can not be forced to take a single sum distribution over $5K out of a qualified DB plan, regardless of whether the plan is terminating or not

I'm not sure where you received this information from. The plan is terminating. Where will the balance of the participants money be if they don't take it all?

When a plan terminates Participants can either rollover the full balance to an IRA or 401(k), which are tax and penalty free. Or take a distribution which would be taxable and depending on age could be subject to an additional 10% penalty.

As to the original poster, I would rollover the monies to an Vanguard IRA and not use any of it to pay consumer debt. At age 55 the tax and penalty aren't worth it. You need to figure out a budget and cut expenses to payoff your debt.

 

[Big_Hitter]

This is a defined benefit plan, not a 401k or profit sharing plan. The normal form of the benefit is an annuity, not a lump sum. That is an optional form of benefit. If the participant does not elect to take a lump sum, they will receive an annuity that will be payable by an insurance company. The plan sponsor has to go out and solicit bids from insurers to take over the annuity payments. Go to the PBGC website and look up standard plan termination.

 

[Big_Hitter]

Standard Terminations

 

[Big_Hitter]

look at the first FAQ

 

[Vetralaivas]

Regarding the lump sum vs annuity: As I mentioned, there would be complications if I were to select the annuity option. I am a trustee of the plan and work closely with our plan administrator. Although frozen for the past couple of years, the plan is well funded. The decision to terminate the plan came as a result of it becoming untenable for the company (a small non-profit) to continue to make large payments (for our small company) to keep the plan in place especially since it was tied to another organization that has since been dissolved.

At the heart of the matter is that I am sort of the 800 pound gorilla in the plan. As I indicated, the plan came with an early retirement subsidy for those who have 25 years of service and have reached age 55. I am the only one who has met this criteria. Payments of course can come in the form of an annuity or a lump sum. The problem is that at today's interest rates annuities are very expensive and to buy an annuity for me to pay out approximately 38K annually would cost about 180K more than what is in the plan. At this point, a relatively straightforward plan termination gets complicated as the plan would not be fully funded. Therefore the PBGC would have to come in and deal with the termination and from what I understand, early termination subsidies would likely suffer or not "honored" so that there would be enough money in the terminating plan to fund all participants. By selecting the lump sum, I am assured of getting a fairly sizeable subsidy and all other plan participants get their appropriate share as well. In addition, there is an excess funding that we share in proportionately. Hope that makes sense.

 

[pb4uski]

....At the heart of the matter is that I am sort of the 800 pound gorilla in the plan. As I indicated, the plan came with an early retirement subsidy for those who have 25 years of service and have reached age 55. I am the only one who has met this criteria. Payments of course can come in the form of an annuity or a lump sum. The problem is that at today's interest rates annuities are very expensive and to buy an annuity for me to pay out approximately 38K annually would cost about 180K more than what is in the plan. ....

This doesn't make sense to me. Immediateannuities.com indicates that a $750k lump sum would buy $42k a year for life for a single male age 56. So if the plan can afford to pay you the $750k lump sum you can then use as little or as much of it as you wish to buy an annuity and if you used the whole lump sum you would get more than if you annuitized.

 

[rodi]

I have to agree with a couple of the others about spending being your key here.

Your 401k balance is relatively low for someone of your age and family income. Over age 50 you can contribute $23k/year... It's pretty evident you haven't been contributing anywhere close to that.

That means the $170k combined income has been consumed for the most part. And you have debt on top of what you paid cash for.

A modest secure retirement is doable - but not if you are spending at the rate you currently are. If you're spending all of the $170k - and spending more (consumer debt) on top of that - you're going to have to make some adjustments.

The good news is your wife's retirement pension is pretty nice. Does it come with COLA adjustments? Does it include healthcare? I assume you're getting employer subsidized healthcare from your employers currently.

As far as your lump sum here's what I would do:
- Figure out your asset allocation. (Percent of equities to fixed income)
- Roll the 401k to a low cost company (Vanguard, Fidelity, Schwab, TDA). Pick low cost index funds or ETFs that fit your asset allocation.
- Don't touch it. Don't pull money out.
- Increase contributions to your 401k.
- Pay down your debt. Double your payments...
- Live within the remainder.

What this will accomplish:
- By diverting money up front to debt reduction and 401k, you learn to survive on less. This will get you comfortable, now, with the budget you're likely to be living with in retirement.
- You'll be reducing your retirement expenses (debt) and increasing your retirement income (401k).

It was a big epiphany to me to realize that diverting money to debt reduction and retirement savings meant I'd get to retirement at a MUCH faster rate - since my spending needs were reduced by what I was diverting.