How to best handle the 5 years prior to retirement

I am a single woman, age 60 with a Simple IRA from a previous employer which is doing well and only $15/yr fees with around $10,000 balance, a 401K from another previous employer that has around $75,000 (includes a Roth) which has low fees and gaining around 4.5%. I have recently started a new job with a 401K, contributing 20% per month (10% traditional, 10% Roth). It has no fees and earning around 3%, with a balance of around $6,000. In the past, I worked for 18 years at a hospital and have a vested pension there. I have been informed that they are closing the pension fund at the end of the year (my vested amount is estimated at around $30,000). These are the options I was given: 1) payout in a lump sum, 2) convert to an annuity and receive around $200/month, or 3) roll over into my current 401K. I currently have an emergency fund of around $30,000. I was initially planning to roll the pension into my 401K, but wondering if I would be better off taking the lump sum, add $20,000 cash with it, and purchase an annuity? I plan to work until 65 at my current job ($60,000/yr) and then maybe work part-time after that. I have no mortgage and no debt.

I would be interested in your thoughts on these options. Thank you in advance for your time!

Before I dive into determining your answer, I want to congratulate you on being debt and mortgage free. Far too often I see people get lined up for retirement only to find out things are going to be tighter than they need to be due to their mortgage that still has 20 years left on it. If you can keep this part of your financial life in check as you enter retirement, the chances of your success increase dramatically. Good job!

Now, without further delay… When I see a bunch of numbers, I get the urge to do some calculating. All of your listed 401(k) assets add up to $91,000. You’re also adding $1,000/month, not counting your employer match. If you maintain this rate of contribution until you retire 5 years from now, and assuming a 3.75% blended return, you could have approximately $175,000 saved for retirement. That sum of money could be expected to safely produce about $410.00 of income monthly.

If you add your $30,000 lump sum pension to the mix, your retirement nest egg could grow to $211,800 by retirement and produce just under $500/month of income.

Finally, if you were able to get the $20,000 cash invested in a way it could grow with a similar rate of return (3.75%), your retirement nest egg grows to $236,000 and produces about $550.00 per month.

I’m not sure how you feel about those numbers, but keep in mind you’ll have a Social Security benefit to help, too.

Let’s look at the lump sum and purchase annuity option. You mentioned you would consider adding $20,000 in cash to presumably get a larger monthly benefit. The potential issue here is you’re talking about mixing two different types of money. Your $20,000 in cash is just that, cash. The tax has been paid and you’re free to do as you wish with it. Your lump sum benefit would still be pre-tax, however. This means you’d either need to buy two separate annuities or, pay the tax on the lump sum (potentially moving you into a higher bracket for that year) and then buy an annuity with a smaller monthly benefit. The taxes wouldn’t stop there, though. Every distribution you’d take from the annuity would be partially taxable to account for the investment gains. Would you owe a bunch of tax? Probably not, but it’s better going into these things with your eyes open. Annuities do offer “guarantees”, though. A consistent stream of income for life can be a difficult thing to say no to.  If that sort of benefit appeals to you, then there probably isn’t much I could say that would change your mind.

What about the option of keeping all of your 401(k) and pension money in the 401(k)? Well, 100% of your distributions would be taxable (as ordinary income) in this case. You’d have the flexibility to take more/less money if you absolutely needed/wanted to at your discretion. But the longevity of the account would be based on how much money you would take in distributions, your investment allocation, and market performance. In other words, you could potentially outlive your money if the stars all align in a certain way.

Without having a few additional pieces of information regarding your circumstances, it’s difficult for me to confidently say one option is better for you than another.  Here’s what you’re going to have to do to know you’re making a good decision.

  • Try and determine what your month to month expenses will be during retirement. You must have an idea of how much money you’re going to need to live the lifestyle you want.
  • You will need to get an idea of what kind of income stream you can reasonably expect from an annuity. In order to find this out, you will probably need to talk to a financial advisor or insurance agent and tell them what you’re trying to accomplish.  
  • Once you have those numbers established, compare your expenses to your projected Social Security benefit. Does the benefit meet your projected income needs? If you still have some expenses left over, does the projected rollover income or annuity provide enough consistent income to satisfy them?

If you’re still coming up with a gap between your projected income and expenses in retirement, you have another alternative available to you. It’s not an option people get excited over and run out to tell their friends about, but it’s often the one that makes everything click.

Work until your full retirement age.

Since you’re 60 years old, your full retirement age is nearly 67 years old. Working until you achieve this magical age accomplishes three things for you: 1) you get a meaningfully higher Social Security benefit for the rest of your life, 2) you will save towards retirement for two additional years, 3) you will delay spending down your retirement savings for two more years. I know those benefits may not seem all that critical, but I can promise you they can be. If you look at your projected numbers for retirement and are at all uneasy about what they’re telling you, consider this option.

You’ve got a little work to do, but it’s work worth doing now. Once all of the information is gathered up, I think the right answer will be pretty obvious for you.

Best wishes!

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