Should I take a partial lump-sum option from TRS?
Educators and administrators enrolled in the Teachers Retirement System (TRS) of Texas have an option of the Partial Lump Sum Option (PLSO) upon separation from service. This blog post will discuss this option and the benefits and drawbacks of taking a PLSO.
What is a Partial Lump Sum Option?
TRS members may select a partial lump-sum distribution that may not exceed an amount equal to 36 months of their monthly pension income. In addition to 36 months, you have two other options for receiving payments covering 12 months and 24 months of your standard monthly pension.1
You can get up to three years of your monthly pension payments in a lump sum. These lump-sum payments can be taken over an annual basis of up to three-yearly payments for 36 months, 1 payment for 12 months, and two payments for 24 months.2
For example, a member who retires at age 60 with a $2,000/month annuity and selects a partial lump sum distribution of 12 months would receive a $24,000 lump sum distribution ($2,000 × 12) plus an $1,809.20/month reduced pension ($2,000 × 90.46%).
With a PLSO, your monthly annuity payments will be actuarially reduced due to the election of PLSO. It is essential to note that selecting a PLSO distribution lowers a retiree's monthly annuity! The PLSO election is irrevocable and cannot be changed.
What are the Tax Consequences of PLSO?
Keep in mind that your PLSO distributions are subject to federal income tax withholding. Since these payments have been identified as eligible rollover distributions, TRS must withhold 20 percent for income tax unless the applicable portion is rolled over into a suitable plan such as an IRA or other qualified plans such as a 403(b) or 401(k). To defer paying taxes on these payments, you may roll over all or a portion of the rollover distribution amount to an eligible employer plan.3
Also, income from the TRS pension is taxable. However, if you roll over that lump sum into your Individual Retirement Account (IRA), you will have much more control over when you remove the funds and pay the income tax on them. But you will eventually have to take the required minimum distributions (RMD) from your IRA at age 72.
What are the benefits of PLSO?
- Can use the PLSO as a reserve for emergencies or unexpected expenses in retirement. There would be a benefit to keeping enough on hand, so you don't put emergency expenses on your credit cards.
- You want flexibility in retirement spending. Taking the partial lump sum gives you the choice of what to do with a portion of TRS retirement. You may wish to pay off your mortgage or other debts, so you don't have these to service in your retirement.4
- You are in a higher tax bracket. You might have other income from a spouse's retirement. If you take the PLSO, you can defer more of your retirement into tax-deferred accounts such as an IRA. As a result, you'll most likely pay less income tax now than if you were taking the maximum monthly payments.
- You don't need additional income each month. For example, if you have other investments, social security, or retirement income from a spouse, you might not need the extra income each month from TRS.
- Rolling your pension into an IRA can give you more options. For example, if you want to minimize your taxes and have investment choices, using a PLSO and putting it into an IRA will allow you to plan when you take your distributions.
- Suppose you are retiring relatively young. Since TRS is not adjusted for inflation, your purchase power erodes over time. In this situation, your investment horizon is longer, which may be better for investments in ETFs or mutual funds.
What are the Drawbacks of PLSO?
- You want the highest amount of monthly, guaranteed pension income possible. However, TRS reduces your monthly payment amount when you take the lump sum. As a result, you may need to have the maximum benefit to cover living expenses. This is especially the case for most Texas teachers that are not eligible to get Social Security. Unless you have additional retirement income, this could significantly impact your standard of living.
- You like to spend money. Some of us want to spend money, and having a lump sum may tempt you to overspend. A 2016 Harris Poll study of retirees revealed that 21% of retirement plan participants who took a lump sum depleted it in 5.5 years.4 One of the main benefits of lump-sum payments is flexibility. But it also invites overspending. Most teachers in Texas are not eligible for Social Security, so they will not get this additional monthly income. In addition, a PLSO further reduces the pension, which puts the pensioner at greater risk.
- You are not savvy at investing in the market or are afraid of losing money. If you have not contributed towards a 403(b) or IRA or invested at all, and you suddenly get a PLSO, you must figure out the right investment mix to match your risk tolerance and time horizon.
PLSO is a great option that should be carefully considered. However, keep in mind your monthly pension will get reduced, which can be difficult for many retirees as they may be tempted to get the additional income upfront, but will pay for it later with a smaller pension down the road. But if you are younger and savvy at investing, you might be able to invest the PLSO or use it to pay down debts and put yourself in a better position for retirement.
It would help if you spoke to a financial planner to determine whether a PLSO is suitable for your particular situation. Reach out to me on the contact page below if you want to learn how the PLSO fits into your retirement goals.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on to avoid any Federal tax penalties. Individuals are encouraged to seek advice from their tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.