| Your retirement savings plan offers you
several choices when you decide to change jobs
or when you retire. This report explains some
of the options you may be able to choose from
in deciding how you want the money in your plan
treated when one of these events occurs.
What Is a Distribution?
A distribution is simply defined as a payout
of the amount of money that has accumulated
in your retirement savings plan. This may include
amounts you have contributed, the "vested"
portion of any amounts your employer has contributed,
plus any earnings on those contributions.
You will want to think carefully before making
any decisions about the money in your retirement
plan, as some choices may mean you have to pay
more in income taxes on your distribution. It’s
also a good idea to talk with a tax advisor
before picking a distribution election.
Some Distribution Options
Keep Money in Employer’s Plan:
Allows continued tax-deferral of any growth.
Make a Direct Rollover: Allows
continued contributions and tax- deferral of
any growth. Avoids potential taxes and penalty
fees.
Take a Cash Distribution: Satisfies
immediate need for cash. Substantial taxes and
penalty fees may apply.
A Look at Some of Your Choices
You may be able to leave your money in the plan;
move it to another retirement savings account,
such as an IRA or annuity, or another employer’s
retirement savings plan if you’re changing jobs;
or take a cash distribution.
- Keep Your Money in the Plan:
You can leave your savings in your employer’s
retirement savings plan if your account balance
was more than $5,000 at any time, depending
on your plan’s rules. Minimum distributions
must begin after you reach age 70 ½, however.
You’ll continue to enjoy tax-deferred compounding
of any investment earnings and receive regular
financial account statements and performance
reports. Although you will no longer be allowed
to contribute to the plan, you will still
have control over how your money is invested
among the plan’s investment options. You also
may still be able to obtain information from
the professionals who manage and administer
your account.
When retiring, you might choose this
option if your spouse is still working or
if you have other sources of retirement
income (such as taxable investment income).
If you’re starting your own business when
you leave the company, keeping your retirement
money in your former company’s plan may
help protect your retirement assets from
creditors, should your new venture run into
unforeseen trouble.
Example: Sue, 58, is retiring from
her full-time job. Her husband is retiring
and the family receives his pension and
Social Security benefits, which will cover
most of their current living expenses. Sue
plans to work part-time at her church after
"retirement" and does not expect
to need her retirement savings for several
more years. After consulting with a tax
advisor, Sue decided that keeping her money
in the company’s retirement plan at least
until she turns age 59 ½ will provide her
with the greatest flexibility in the future
- Move Your Money to Another Retirement
Account: You can move your money
into another qualified retirement account,
such as an Individual Retirement Account (IRA),
or, if you’re changing jobs, your new employer’s
retirement savings plan. With a "direct
rollover," the money goes directly from
your former employer’s retirement plan to
the IRA or new plan, and you never touch your
money. With this method, you continue to defer
taxes on the full amount of your plan savings.
Example: Bill is taking a new job at a different
company. He elects to roll over balances from
his existing plan into an IRA rather than
transfer his assets into his new employer’s
401(k) plan. This provides Bill with a much
broader choice of investment options.
- Take a Cash Distribution:
You can choose to have your money paid to
you in one lump sum, or in installments of
a fixed amount or over a set number of years,
depending on your plan’s provisions. However,
you may have to pay taxes on a cash distribution
and, if you’re under age 55 at the time when
you leave your job, you may also have to pay
a 10% penalty for early withdrawal.
Retirees Should Consider Tax Consequences
If you’re retiring, you will want to take into
consideration whether favorable tax rules apply
to your lump-sum distribution. To qualify as
a lump-sum distribution, you must receive all
the amounts you have in all your retirement
plans with a company (including 401(k), profit-sharing,
and stock-purchase plans) within a one-year
period.
Potentially favorable tax rules that may apply
to a lump-sum distribution include the minimum
distribution allowance and 10-year forward income
averaging if you were born before 1937.
Ten-year forward income averaging:
The taxable part of the distribution is taxed
at special rates based on levels for single
taxpayers in 1986.
Example: Ron, born in 1936, is retiring in
three months. He met with a financial advisor
to determine which distribution method would
result in the greatest benefit after taxes.
His advisor showed him that, under some assumptions
about inflation and future rates of return,
his best course would be to take a lump-sum
distribution and use 10-year forward income
averaging. Under other assumptions, he would
benefit from leaving his money in the company
plan or rolling it over directly into an IRA.
There may be other distribution options available.
Contact your plan administrator for information
on all options available under your plan.
Withholding on Cash Payments
If you choose to physically receive part or
all of your money (say, $10,000) when you retire
or change jobs, this action is considered a
cash distribution from your former employer’s
retirement account. The cash payment is subject
to a mandatory tax withholding of 20%, which
the old company must pay to the IRS, and possibly
a 10% penalty if you are under age 55 at the
time you left the company.
You can avoid paying taxes and any penalties
on a cash distribution if you redeposit your
retirement plan money within 60 days to an IRA
or your new employer’s qualified plan. However,
you’ll have to make up the 20% withholding from
your own pocket in order to avoid taxes and
any penalties on that amount. The 20% withholding
will be recognized as taxes paid when you file
your regular income tax at year end, and any
excess amount will be refunded to you as an
IRS refund.
The Potential Cost of a Cash Distribution
Distribution - 20% Tax Withholding = Amount
in Your Pocket - 10% Penalty
$10,000 distribution - $2,000 Tax Withholding
= $8,000 in Your Pocket - $1,000 Penalty
If you are under age 55 when you separate from
service with your employer, and choose to take
a cash distribution, be aware of how it can
immediately whittle away the money you’ve worked
so hard to save. You can take a cash distribution
and avoid the 10% penalty so long as you roll
over the entire $10,000 within 60 days into
an IRA or your new employer’s qualified plan,
even though you actually received only $8,000
after paying the 20% tax withholding. In that
case, $2,000 will have to come out of your pocket.
As with all retirement and tax planning matters,
be sure to consult a qualified tax and financial
planning professional to ensure that your planning
decisions coincide with your financial goals.
Points to Remember
1. A distribution is a payout of realized
savings and earnings from a retirement plan.
In general, you must begin taking distributions
from your account by April 1 of the year following
the year in which you turn 70 ½, unless you
are still working for your employer.
2. Your distribution options include keeping
your money in your plan; enacting a direct
rollover; or taking a cash distribution.
3. If you keep your money in your plan you
will no longer be able to make contributions,
but you still maintain control over the investments
and any growth continues to be tax deferred.
4. In a direct rollover, you have your money
moved directly to a qualified plan or IRA
without physically receiving a cent. If you
are under age 55 at the time of separation
from service, a direct rollover may be a good
option, as it avoids the hefty taxes and penalties
associated with a cash distribution.
5. Although a cash distribution is perhaps
the most enticing option available, consider
that you must pay taxes on the money you receive
at then-current rates. And if you are under
age 55 when you leave your employer, you may
have to pay Uncle Sam 10% of your savings
in penalties.
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