Lump sum distribution of pension - how to determine value - how it is taxed

[Gordon3]

I am considering early retirement and want to understand the implications of taking an optional lump sum distribution.

• One concern deals with calculation of the lump sum value.
  • How is the value of a lump sum pension distribution calculated?
  • What are “Minimum Present Value Segment Rates” and how are they used?
• Another concern deals with taxes owed on the lump sum.
  • How is a lump sum distribution of a pension taxed?
  • Can the lump sum distribution from a pension be rolled over to an IRA or even better, a Roth IRA?

For context, my current employer uses Fidelity to administer benefits.  I am eligible for early retirement.  I am married, so any lump sum requires documented spousal consent. I have two different pension plans as well as a 401(k), all with this same employer. I also have unrelated traditional and Roth IRAs that are outside of the company plans. One of the employer sponsored pension plans stopped receiving credits on December 31, 2004, and I have the option of receiving a lump sum distribution on that pension after leaving the job and prior to age 72, or I could decide to start receiving a stream of monthly payments at a chosen time in that same period.

Regarding calculation of the lump sum value:

Discussion with Fidelity regarding the value of the lump sum distribution leads me to think that a Present Value calculation is performed using [what Fidelity referred to as] 417(e) PPA interest rates with a four month lookback.  Presuming that this is about a Present Value calculation, the Discount Rate to be used in that calculation is needed. While I wait for whatever Fidelity will send via mail, I found the following.

• “PPA” seems to refer to the Pension Protection Act of 2006.
  • Going back to the original text of the Pension Protection Act of 2006 gives the impression that Section 417 must have been added after the original act became law.
  • That law appears to have been further adjusted by some combination of the SECURE Act, the American Rescue Plan, the Infrastructure Investment and Jobs Act, and perhaps SECURE 2.0.
• In sifting through this attempt to determine how to calculate the lump sum value,
  • “Pension Plan Funding Segment Rates” or “Segment Rates” come up.
  • “Minimum Present Value Segment Rates” also come up.
• The “Minimum Present Value Segment Rates” table from the IRS website provides monthly interest rate values for three segments.
  • Though I did not find it in plan documentation, nor on the IRS website (it could be there), I did find indications that
    • The First Segment is related to Year 0 through Year 5 of the period in which monthly payments could have been received rather than a lump sum.
    • The Second Segment applies to Year 6 through Year 20.
    • The Third Segment applies to Years > 20.
  • Is the lump sum value calculated as the sum of three present value calculations?
    • Lump Sum  = (Present Value of First Segment) + (Present Value of Second Segment) + (Present Value of Third Segment)
  • What number of periods should be used for the Third Segment?
    • Is that left for a retiree to guess?
  • What is the correct way of calculating the lump sum value?
• I believe there are other considerations
  • A stream of payments (or annuity) is considered low risk in that the payments are assumed to be made.
  • Inflation will reduce the value of a stream of payments over time.
  • Putting inflation aside, a long lived beneficiary will receive a greater benefit than a short lived beneficiary of the same or equivalent annuity.
  • However the lump sum discount rate is determined, a higher interest or discount rate will result in a lower lump sum.
  • Are the above correct?
  • Other than taxes, is there more to be considered?

Regarding taxes owed on a lump sum, how is that determined?

Do I have the option to roll over the lump sum into either a Traditional or a Roth IRA?

[fanfare]

if you are exiting the company and have the option of taking a lump sum, you must also have the option to have the company roll it into your IRA directly.

if your company is not offering this, don't do it.

@Gordon3 

[Mike9241]

you really need the services of a financial planner because in some ways were working in the dark as to what is best.  if you take a lump sum, the taxable portion adds to your ordinary income and is taxed. you may be able to use 10-year averaging on a lump sum distribution. use part I of form 4872 to see if you qualify.

https://www.irs.gov/pub/irs-pdf/f4972.pdf   or you can roll it into an IRA tax free and RMD distributions would have to start based on current law by 4/1 of the year following the year you turn 72 (age 72 distribution).  if you do this rather than taking a distribution in the year you turn 72 you would also have to take a second RMD distribution before the end of the year (age 73 distribution). there afeter an RMD each year.  a direct rollover (trustee to trustee) is best because there is no withholding. if you got the money, you have 60 days to put it into an IRA. miss the deadline and your taxed on the entire taxable amount. if taxes are withheld and you don't make it up with personal funds then the withholding is treated as a taxable distribution.  rolling into a ROTH IRA would make the entire taxable portion of the distribution taxable.  or you can take your employers offer of an annuity. IRC 417 is only for purposes of determining the minimum amount of a survivor annuity for a defined benefit pension plan when there's an election to waive a qualified joint and survivor annuity. the value of your account is based on the plan documents so the "minimum could be higher". the human resource department of your employer or Fidelity can tell you the value. we can't just too much info were missing.  

**********************

A QJSA is when retirement benefits are paid as a life annuity (a series of payments, usually monthly, for life) to the participant and a survivor annuity over the life of the participant’s surviving spouse (or a former spouse, child or dependent who must be treated as a surviving spouse under a QDRO) following the participant’s death.

The amount paid to the surviving spouse must be no less than 50% and no greater than 100% of the amount of the annuity paid during the participant’s life. Alternatively, a participant who waives a QJSA may elect to have a qualified optional survivor annuity (QOSA). The amount paid to the surviving spouse under a QOSA is equal to the certain percentage (as chosen) of the amount of the annuity payable during the participant’s life.

*******************************

• I believe there are other considerations
  • A stream of payments (or annuity) is considered low risk in that the payments are assumed to be made.  maybe maybe not. see above 
  • Inflation will reduce the value of a stream of payments over time. of course
  • Putting inflation aside, a long lived beneficiary will receive a greater benefit than a short lived beneficiary of the same or equivalent annuity.  for a QJSA yes, but that does not take into account what the survivor may receive, and should the "survivor" predecease the participant ????????????
  • However the lump sum discount rate is determined, a higher interest or discount rate will result in a lower lump sum.  YES. 
  • Are the above correct?
  • Other than taxes, is there more to be considered? many. what do you want to do with the money, your ages and life expectancy. your health. 

we know nothing about your finances. you are just looking at what appears to be a small piece. using a financial planner is advisable especially if you have a substantial net worth.  

[Gordon3]

I do appreciate the replies, however I'm not asking for suggestions regarding what others may think is best for me. I am asking how to do a calculation.

• How is the value of a lump sum pension distribution calculated?
• How are the “Minimum Present Value Segment Rates” used in that calculation?

What would help is to have an Excel formula for calculating the lump sum amount based on the three segments called out in the “Minimum Present Value Segment Rates” table. I've never seen PV calculated as three segments with three interest rates.

I think I found something helpful on slides 11 through 18 here (but it appears to be from 2014): https://www.asppa.org/sites/asppa.org/files/PDFs/Education/Conferences/AAS14/Session%203%20-%20IRS%2...

I'll eventually find the answer and post.