Where to put small-ish pension lump sum?

[zolotiyeruki]

This isn't a big enough question to post in the Case Studies subforum, so I thought I'd put it here.  I had 6 years of service with Megacorp, and left 11 years ago.  I'm vested a bit into their pension, and they are offering early dispursement:  a small annuity now, a larger annuity way later, or a lump sum paid a few months from now.  I'm currently 41, MFJ, in the 22% bracket, and conservatively plan to retire in 10 years (and hopefully well before then!).  We're about halfway to "the number," with about 15% of our investments in "accessible" locations like Roth contributions and taxable brokerage accounts. I fully anticipate that we will be in the 12% tax bracket in retirement.

I plan to take the lump sum, but the question is where to put it.

Option 1: Roll it into an IRA.  Advantages:  Avoid taxes while I'm in a high tax bracket.  Disadvantage: funds will be less accessible for a long time, and I really would like to boost our accessible assets in preparation for a Roth Pipeline.
Option 2: Roll it into a Roth IRA.  Advantages:  Can be withdrawn after 5 years, tax-free growth.  Disadvantage: have to pay taxes now at 22%, although I think we'll still be able to contribute to our Roth IRAs
Option 3: Take it as income for taxable investments.  Advantages: maximum flexibility, both in terms of investment options and withdrawal options.  Disadvantage: pay taxes now at 22%

I have to make the decision fairly soon, and I'm *really* torn.  I really like minimizing taxes, but I also really like the idea of plowing a whole bunch of money into my Roth IRA (since my current employer's plan doesn't allow a mega backdoor Roth), but I also have some off-the-market investment opportunities coming up, and even if I decide to stick to index funds, it would be huge for helping us get those first five years' expenses saved up.

Are there some aspects of this that I haven't yet considered?  Which would you suggest?

[Morning Glory]

I assume you've already calculated that the lump sum is worth more than any of the annuity options.

I did the traditional IRA rollover with mine last year (~87k),  but I also lived in a state with high income taxes so I did traditional everything  as a general rule.

 It's fair to look at traditional vs Roth, but would you normally Roth-convert such a sum while still working? Any benefits you might lose if your AGI is that much larger?

 I think taking it as income comes with a penalty on top of your marginal rate, just like a 401k distribution, but I can't remember for sure.

[zolotiyeruki]

I assume you've already calculated that the lump sum is worth more than any of the annuity options.

I did the traditional IRA rollover with mine last year (~87k),  but I also lived in a state with high income taxes so I did traditional everything  as a general rule.

 It's fair to look at traditional vs Roth, but would you normally Roth-convert such a sum while still working? Any benefits you might lose if your AGI is that much larger?

 I think taking it as income comes with a penalty on top of your marginal rate, just like a 401k distribution, but I can't remember for sure.

From what I've read in the information packet, it sounds like I would only owe regular income tax.

[reeshau]

I assume you've already calculated that the lump sum is worth more than any of the annuity options.

I did the traditional IRA rollover with mine last year (~87k),  but I also lived in a state with high income taxes so I did traditional everything  as a general rule.

 It's fair to look at traditional vs Roth, but would you normally Roth-convert such a sum while still working? Any benefits you might lose if your AGI is that much larger?

 I think taking it as income comes with a penalty on top of your marginal rate, just like a 401k distribution, but I can't remember for sure.

From what I've read in the information packet, it sounds like I would only owe regular income tax.

The CFPB says otherwise:

"In addition to paying income tax, you will owe an additional 10 percent penalty tax, if you take a lump-sum payout before age 59½."

https://www.google.com/url?sa=t&source=web&rct=j&url=https://files.consumerfinance.gov/f/201601_cfpb_pension-lump-sum-payouts-and-your-retirement-security.pdf&ved=2ahUKEwjwqauKutf3AhW8j2oFHamlCyoQFnoECAQQAQ&usg=AOvVaw2wYEng6Kfg1iUNMh1NRWfc

I'm sure the IRS does too; only in more obtuse language.  Although taxes are not required to make sense, it does make sense that traditional pensions are treated this way, since you could otherwise roll it over into a traditional IRA.  No loophole here.

[zolotiyeruki]

Well, gee, that makes the decision easier, then.  To an IRA it goes!  So....Roth, or Traditional?  Given that most of our retirement savings is in traditional, I'm leaning toward Roth now.

[simonsez]

@zolotiyeruki  Just to make sure I'm understanding this - if you put the lump sum pension payout in a Roth IRA, you are saying you avoid the 10% penalty.  You can take out seasoned rollover contributions to a Roth IRA penalty-free regardless of age so if you did that hypothetically before 59 1/2 would you have to pay 10% then or it's bypassed forever?  If I retire early and was considering taking a lump sum pension payout, this 10% penalty bypass could be a valuable strategy.  Just wanted to doublecheck this!

[zolotiyeruki]

@zolotiyeruki  Just to make sure I'm understanding this - if you put the lump sum pension payout in a Roth IRA, you are saying you avoid the 10% penalty.  You can take out seasoned rollover contributions to a Roth IRA penalty-free regardless of age so if you did that hypothetically before 59 1/2 would you have to pay 10% then or it's bypassed forever?  If I retire early and was considering taking a lump sum pension payout, this 10% penalty bypass could be a valuable strategy.  Just wanted to doublecheck this!

That is my understanding--once the rollover has seasoned for five years, it can be withdrawn with no penalty or tax.

[Catbert]

I would probably put it in a Roth and pay the 22% tax.  As Morning Glory mentioned there may be other more subtle considerations:  Would you owe a state tax now that wouldn't apply later bc you'll change states?  Would the additional income now put you over a threshold for some other tax deduction?  Would the additional seasoned Roth help you meet ACA subsidies when you retire?

[zolotiyeruki]

Would you owe a state tax now that wouldn't apply later bc you'll change states?Good question.  We *would* like to move somewhere when I retire, but that location has a similar income tax rate to our current location.
Would the additional income now put you over a threshold for some other tax deduction?I don't believe so.  The only thing I think I might run into would be the phase-out of Roth contribution eligibility, but a quick back-of-the-envelope calculation indicates I can easily be below that.
Would the additional seasoned Roth help you meet ACA subsidies when you retire?Thanks, I hadn't considered that aspect of it.  Certainly I would expect it to, since those withdrawals would not count against AGI.

[zolotiyeruki]

Wanted to follow up on this.  We decided to roll it over into the Roth IRA.  It's tax-inefficient for people working until age 59.5 or later, but I'd rather take a minor-ish tax hit now rather than work an extra several years.