Key Points
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 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% Penalty1 |
| $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
- 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.
- Your distribution options include keeping your money in your
plan; enacting a direct rollover; or taking a cash
distribution.
- 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.
- 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.
- 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.
1Additional taxes may be due, depending upon
individual's tax bracket.
© 2011 McGraw-Hill Financial Communications. All rights
reserved.
