Leaving a job? Here's what to do with your pension
Besides your 401(k) balance, you may have to choose what to do with your defined-benefit pension if you have one.
By Jeanne Sahadi, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) -- -- From the "no rest for the weary" files comes this mini-dilemma:

You're lucky enough to work for a company that provides a defined-benefit pension. But when you leave for another job, your company gives you a choice: take the pension benefit you've accrued to date in the form of a lump-sum today or wait to collect its monthly equivalent when you retire.

For instance, a woman in her early 30s is moving to a new job and was given the following choice from her current employer: take with her the $5,000 she's accrued in pension benefits so far or let the money stay in the pension plan and collect $170 a month for life when she retires in 33 years.

That's not a king's ransom certainly. But in this instance the woman worked at the company for less than 5 years, which is typical for younger workers. And as people switch jobs more frequently in the course of their career, it's likely that they'll accrue pension benefits that will only form a small percentage of their monthly retirement income.

Nevertheless, it's real money that should be maximized, and the decision can become more complex the older you are and the larger the benefit to which you're entitled.

Brian Graff, executive director of the American Society of Pension Professionals & Actuaries, and Kevin Wagner, retirement practice director at Watson Wyatt helped us think about how to decide whether it makes sense to take a lump-sum payout when you leave.

Consider these questions:

Can I do better investing the lump-sum myself?

When your employer calculates the present value of your future benefit -- both as a lump sum and as a monthly benefit -- it must use what's known as a discount rate, which under current law is tied to the interest rate on the 30-year Treasury.

In the example of the woman above, the discount rate is 4.73 percent.

The younger you are and the more years you have until retirement, the more likely it is that your investments will outperform the 30-year Treasury rate on an average annual basis. "I'd find it hard to imagine for anyone under 40 it being worth it to defer (taking their benefit),"Graff said.

For instance, if you have 33 years to invest and assume you can get a 6 percent annual return on a $5,000 investment, you'd have $34,203 at retirement, which can purchase a monthly annuity worth $225.

(The number would be a bit lower if you compare the payouts from annuities that pay a benefit to your spouse or other survivor after your death.)

The older you are -- particularly if you're in your mid-50s and up and have some serious tenure at a company -- you also want to consider whether your employer will goose your benefit to encourage you to leave the money in the plan rather than taking the lump sum, which at that stage in your career is likely to be large. The employer has an interest in keeping such large sums in the plan to make the plan's cash flow look better.

Plus, your investments may not be able to outperform the 30-year Treasury rate if your time horizon to retirement is short.

How sound is my company?

If you think your company might be at risk of bankruptcy, that could mean it would terminate its pension plan and turn it over to the Pension Benefit Guaranty Corp., which insures pensions get paid but only up to a cap. (Here's the PBGC's table of monthly maximium guarantees.)

If your pension would exceed the PBGC cap, you risk forfeiting the difference if your pension plan goes under.

But the chances of bankruptcy aren't great for a large number of companies and many plan participants don't have pensions exceeding PBGC caps.

What's the best way to manage a lump sum?

Your best bet -- i.e., the simplest and least susceptible to financial headaches -- is to instruct your company to directly rollover the money into an IRA that you've set up.

If they cut a check to you, things can get sticky ... and expensive. Here's why:

If you plan on spending your lump sum, you'll have to pay income tax and a 10 percent penalty. Translation: Don't do it. Not only do you forfeit 10 percent of the benefit you've accrued, but the money will be much more valuable to you when you retire.

If you plan on rolling over the money yourself, you'll have to mind your watch and pay some money up front before getting reimbursed.

That's because you must rollover your money within 60 days of receiving your check. Otherwise, Uncle Sam will assume you're taking an early distribution and will impose the income tax and 10 percent penalty.

Plus, even if you meet the 60-day deadline, you'll have to pay out of pocket to make sure the right amount of money gets rolled into your account. That's because your company automatically withholds 20 percent for Uncle Sam's benefit.

Say you're entitled to a $100 lump-sum. Your company will cut you a check for $80, but you'll be required to rollover $100 into your IRA so that the payout isn't considered taxable. So, you'll have to fork over $20 for the rollover. You'll get it refunded to you the next time you file your federal income tax return.

How should I invest the lump-sum?

If you're not interested in monitoring your investments, you might opt to invest your pension money in a target-date retirement fund, which invests in an asset mix suitable to your time horizon -- it grows more conservative as you approach retirement.

Or you might assess how the rest of your retirement money is invested and choose a total market index fund that best suits your asset allocation. There are index funds for U.S. stocks, for non-U.S. stocks and for bonds. Top of page

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