Paying credit card debt with a pension

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Q. I have a pension worth about $500 a month, and the lump sum payout is $38,000. I’m only 34 and I’m not sure if I should leave it there or invest the lump sum in an IRA. I also have $5,000 in credit card debt. Could I pay it off and roll over the rest into the IRA?
— Unsure

A. Not many people have to face the choice of what to do with a pension.

These days, it’s a good choice to need to make.

The most important factor will be knowing what you want: either having the security of a monthly pension for the rest of your life or having control of the money, how it is invested, and how it will be handed down to your heirs, said Jim McCarthy, a certified financial planner with Directional Wealth Management in Rockaway.

“Think of it as security with no control (pension) versus control with no security (lump sum),” McCarthy said.

He said to equate your two options, advisors use time value of money calculations.

Money value fluctuates over time, he said. Generally, a $1 today is worth more than a $1 in the future.

It’s impossible to give you a definitive answer because we won’t know when the pension should begin and if there are any inflation adjustments for the pension, but here are some ideas to get you started.

For example, McCarthy said, if we assume that the pension payments will start when you are 65 with an inflation adjustment of 3 percent, and your life expectancy is age 90, you would have the equivalent of $104,478 at age 65.

There are normally two options for receiving a pension — a single life annuity or a survivorship annuity.

With single life you will have a higher payment but it will only last your lifetime, whereas the survivorship pension will be a lower amount but will last for both your spouse and yourself — assuming you are married at that time, McCarthy said.

“If we look at the lump sum payout, assuming an average annual return of 5 percent from now until you turn 65, you will have the equivalent of $149,755 at age 65,” he said. “This assumes you will first pay off the credit card debt.”

So you can take a portion of the lump sum to pay off your credit cards and then roll over the balance to an IRA. However, he said, any portion of the lump sum not rolled over will likely be subject to a 10 percent federal income tax penalty for early distribution and the amount will be counted as ordinary income for income tax purposes.

So based on the time value of money and the assumptions above, McCarthy said it would sense to take the lump sum now because the equivalent value is higher.

“Changing any of the variables — when the pension starts, inflation adjustment, investment rate of return, etc. — may change the outcome,” he said.

He recommends speaking with a certified financial planner about the details of your options, and also to a licensed tax professional about taking a portion of the lump sum to pay off debt.

“Also before deciding, ask yourself: are you confident that you will be able to handle the risk necessary to grow the lump sum to provide a stream of income later?” McCarthy said.

If you don’t think you’d invest as needed, that could change your outcome significantly.

For more specific advice about your entire money situation, a consider a free money makeover with NJMoneyHelp.com. Just send us an email.

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This post was first published in August 2016.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.