Should I take a partial lump-sum option from TRS?
For educators and administrators enrolled in the Teachers Retirement System (TRS) of Texas, they have an option of the Partial Lump Sum Option (PLSO) upon separation from service. This blog post will discuss what this option is, 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 which 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
Essentially, 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 very important to note that selection of a PLSO distribution results in a reduction of 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 eligible portion is rolled over into an eligible plan such as an IRA or other qualified plans such as a 403b or 401k. To defer paying taxes on these payments, you may roll over all or a portion of 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 required minimum distributions 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 want 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. If you have other investments, social security, or retirement income from a spouse, you might not need the additional income each month from TRS.
- Rolling your pension into an IRA can give you more options. 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.
- If 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. When you take the lump sum, TRS reduces your monthly payment amount. 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 have a significant impact on your standard of living.
- You like to spend money. Some of us like to spend money and having a lump sum may tempt you to overspend. In fact, 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. 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 403b or IRA or invested at all, and you suddenly get a PLSO you would have to figure out the right investment mix to match your risk tolerance and time horizon.
PLSO is a great option that should be carefully considered. 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.
You should speak to a financial planner to determine whether a PLSO is right for your particular situation.
*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 for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own 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.