February 12, 2011

Pension Options - The PLOP Discussed

Starting in July 2004, when educators in Georgia were retiring and deciding on the various pension options, they were also given an additional option at the time of retirement - "you may also elect to receive a one time lump-sum distribution (cash payment) in addition to your monthly retirement benefit." This became known as a Partial Lump-Sum Option Plan or "PLOP" to most educators.

First, let me point out that the TRS's website does a very good job of describing the various options and gives an example. To go to the TRS site and "Educate Yourself" on the PLOP, please click here. This link takes you to the first of many pages detailing the option. Also, "TRS encourages you to seek assistance from a financial advisor and/or a tax professional. A PLOP used to enhance retirement income or savings may merit consideration. A PLOP used to purchase depreciable assets or used for leisure should be given careful consideration as these purchases may compromise long-term retirement income."

Now, let's back up to understand why I am discussing this subject. Essentially, I have received a number emails over the last few years questioning using a PLOP for various reasons. Unfortunately, there is not one simple answer that I can give to everyone because age, health, reason for the distribution, tax brackets, beneficiaries, other income, etc. all play a roll in making this decision. What I can say is that I have been told that people want to use a PLOP to: pay off their house, go on vacation, spend it, buy a car, a child's wedding, and to "control it." All of these ideas hold some merit, but when you are taking money from your retirement, you run the risk of hurting your future retirement income stream (your pension amount) and in the short term, you create a taxable event if the PLOP is not rolled over to an IRA account.

For example, if you take a $50,000 PLOP (as the TRS example explains) to buy a car and go on a once in lifetime vacation, you will be incurring a hefty IRS and Georgia tax, and you can take on an extra 10% if you are under 59.5. A rough estimate for a 55 year old taking a $50,000 PLOP to spend and not rollover into an IRA is easily $17,500 which is 35% (10% tax penalty, 20% federal, and 5% Georgia). Granted, this is just a rough estimate, so anyone's potential tax could be higher or lower than this estimate.

Now, I have also been asked about using a PLOP as a way to make sure that contingent beneficiaries (of the pension) receive some of the benefit of an educator's working years. I definitely understand this thinking, but I would argue that taking the full pension amount (using whatever option you choose) then buying life insurance instead may be a better solution. Yes, you are paying for coverage, but the potential payout to your beneficiaries may out weigh the costs.

Using the TRS example, a retiring, 60 year old male in decent health could get a $500,000, 20 year term life insurance policy for $246-298 a month (based on an on-line quote from eterm.com). This would mean that the retiree would still have at least $75 more a month than taking the $50,000 PLOP... and the $75 would increase every year based on COLAs.

In the end, the main idea in today's post is that there are various issues and options for a retiring educator to consider. A PLOP sounds like a great idea, and it could be in one case, but it could also hamper future retirement income beyond recovery in another case. This is why it is a great idea to sit down with a financial advisor and/or tax professional to discuss the options before any final decisions are made.

7 comments:

Anonymous said...

I am a retiring teacher. If I take a PLOP in the Year I turn 55 after 33 years of service which is more than full retirement in Georgia do I have to pay the 10%penalty? Thank you.

David said...

" . . . you will be incurring a hefty IRS and Georgia tax, and you can take on an extra 10% if you are under 59.5. A rough estimate for a 55 year old taking a $50,000 PLOP to spend and not rollover into an IRA is easily $17,500 which is 35% (10% tax penalty, 20% federal, and 5% Georgia). Granted, this is just a rough estimate, so anyone's potential tax could be higher or lower than this estimate."

Robby Schultz said...

Thanks for answering the question David. I am not sure why, but I have not received all of the questions that have been posted as comments.

Thanks again,
Robby

Kathy said...

If I ask for 50,000 and pay 17, 500 in taxes, can I get any of those taxes paid back?
Kathy

Robby Schultz said...

Kathy,

Thanks for your question and for reading the blog.

I guess my question here is why would you want to take the $50k? Yes, if you withhold $17,500 in taxes, and you end up with a tax bill less than that, you would get a refund, but why would you want to incur the tax?

If it is to buy a car, pay off the house, etc., it is still not worth it. You are lowering your future pension for a one time expense and getting hit with a huge tax bill because of it.

There are very, very, very few reasons why taking the PLOP is a better idea than the pension, but if you have something in mind, I would love to hear about it. Maybe you have something that I have never thought of previously.

Feel free to email me at rschultz@rollinsfinancial.com to explain and discuss it more.

Thanks again!
Robby

Anonymous said...

This is an older blog post, but I'm just now reaching retirement point. My reason for taking the PLOP is to pay off all of my debt (except the house)and I will still have a sizeable chunk of $ left over to be self insured against any large expenses. I realize I will take a large tax hit, but it seems worth it considering the small amount it actually impacts my monthly income. I plan to take a year's salary. I imagine I'm like most people and started adult hood behind the 8 ball (student loans, etc.), incurring debt and spending most of my working career trying to pay it off. This appears to be my one chance to get an upfront payment that will put me on the other side. Maybe I'm missing something in my analysis of this, but I can definitely afford to live with a slightly reduced income if my debts are gone.

Robby Schultz said...

Thank you for your comment, and I do understand your thinking, but I would certainly disagree. You are making a decision that looks solely at today and not the long term future. Also, once you start on the pension there is not another opportunity to take a distribution for large expenses.

For example, let's say you want to pay off $40,000 of debt. Depending on timing and other income, that is going to be taxed at a minimum of 20% federal and most likely higher. If you are in Georgia, add an additional 6%. If you are under 59.5, you will have a 10% penalty too... Thus to get $40,000 net of taxes, you need to take $66,667 - and the taxes might be even higher.

I am just guessing here, but I am guessing you are not paying 40% in interest.

A better alternative would be to sit down and figure out where you are financially. For example, when a potential client comes to me, I have a long discussion about their entire financial life. We get all of the assets and all of the debts, and then start making some calculations going forward.

If you have a large amount of equity in your home, potentially a HELOC to pay everything off, lower the interest rate, and make the interest deductible is possible. Is there other assets/savings that would be better used to reduce the debt?

Feel free to email me at rschultz@rollinsfinancial.com to have a further discussion. I am happy to help.

Thanks again!
Robby