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Retirement Planning

Retirement Account Services | What Should You Do With Your Retirement Plan Payout?

Many people chose to have their retirement plan distribution "rolled over" to an Individual Retirement Account or another employer's tax-qualified retirement plan as a way to avoid immediate taxation. Any amounts rolled over (plus any earnings) are not taxed until they are taken out of the IRA or other plan. And amounts rolled over are not treated as early retirement plan distributions, and therefore are not subject to the tax law's 10% penalty.

You may roll over any "eligible rollover distribution" to an IRA. Basically, most non-annuity payments from a plan will qualify. These include single distributions, as well as installments over less than ten years.

You can roll over the distribution to an IRA on your own, within 60 days of receipt of the money. Preferrably, your employer's plan can transfer it directly to the IRA for you. If you receive the payment first, a 20% withholding tax will be taken out. Then, at the time you roll over the entire taxable distribution, you will have to make up the 20% "shortfall" out of other funds.

A rollover IRA offers other advantages besides tax deferral. You can obtain professional investment management of your retirement fund. And you can take retirement withdrawals from the IRA in a way that meets your specific needs.

Rollover IRAs can be very flexible. For example, you needn't put all of your distribution into an IRA. You could, for example, roll over part of the distribution and keep the rest (to pay for a well-deserved vacation, perhaps). The amount you keep will be taxed. But the amount you roll over stays tax deferred.

A wide range of investments are available through a rollover IRA. Stocks, bonds, certificates of deposit, money market investments - these are just some of the many options you may have. You can set up a rollover IRA in which you have full investment control. Or you can establish a rollover account through which an investment manager invests your retirement money for you. You make the decision that is right for you.

For most recipients of retirement plan distributions, a rollover IRA offers overwhelming advantages. But a rollover is not always the best alternative. Tax advice is essential.

Whether or not a rollover IRA works for you, our retirement planning professionals can help you set up your IRA. We also offer a broad array of flexible investment management alternatives. We will help you structure a program that best suits your needs and objectives.

Questions and Answers About IRA Rollovers

What is a "Rollover" and what are its advantages?

A "rollover" is a transfer of your money from a tax-qualified pension, profit sharing, or other retirement plan to an Individual Retirement Account (IRA) or other qualified plan. The rollover must be made within 60 days after payment. When you roll over an eligible distribution to an IRA or other qualified plan which accepts rollovers, you continue to shelter your money from income taxes. You won't be taxed until you withdraw your funds from the rollover IRA or other plan. You'll also defer tax on the investment earnings on the amount rolled over.

The tax law coins a phrase - "eligible rollover distribution" - and spells out exactly which distributions you can roll over.

Is there any way other than a rollover to avoid income taxes on my distribution?

No. If your distribution is considered taxable (that is, it is not a return of after-tax contributions which you made to the plan), a rollover is the only way you can continue to avoid taxes on the distribution. Although a rollover is frequently the most beneficial course of action from a tax point of view, sometimes it may be more advantageous to take a distribution and pay income taxes. This may be true, for instance, when a distribution qualifies as a "lump-sum distribution." The tax law provides special favorable methods of computing taxes (forward averaging, for example) on qualifying lump-sum distributions which meet specific requirements. Generally, these favorable methods apply once in a lifetime. You should check to see if you qualify for these special methods before making a decision to use a rollover IRA.

Can I take part of my distribution in cash and roll over the remainder?

Yes, As long as your distribution is an "eligible rollover distribution." Just remember that you'll be taxed on the money you don't roll over (unless it's attributable to an after-tax contribution). You'll also forfeit any opportunity you may have had to use forward averaging to compute your tax on the distribution. If you're under age 59 ½ when you receive the distribution, you may also have to pay a 10% penalty tax on the amount that's not rolled over.

How does the federal income-tax withholding requirement affect my distribution?

A plan must hold 20% from your "eligible rollover distribution". This amount will be sent to the IRS as withheld income tax. When you file your income-tax return for the year, you will report the withheld taxes as a credit against any income taxes you owe for the year.

Does withholding apply even if I intend to roll over my distribution?

Yes. If the distribution is made to you, you will receive only 80% of the total - regardless of whether you intend to roll it over or not. To accomplish a rollover of 100% of your distribution, you will have to replace the 20% that was withheld. Otherwise, the missing 20% will be treated as taxable distribution to you (and you may owe the 10% penalty tax on that amount as well).

Is there any way around the withholding requirement?

Yes. The tax law contains a special provision that allows you to avoid the withholding requirement. All qualified retirement plans must give you the option to have your eligible rollover distribution directly transferred from the paying plan to an IRA or another employer plan that accepts rollovers. When your funds are directly transferred by means of a trustee-to-trustee transfer, no income tax will be withheld. However, a plan may or may not permit direct rollovers of small amounts - check with the plan administrator if you wish to make a small direct rollover.

Where can I learn more about IRA rollovers?

There are several sources available. The plan's service provider, for example, offers a variety of IRA rollover alternatives. One of their experienced professionals is available at your convenience to discuss your options with you and assist you with the necessary paperwork if you decide an IRA rollover is the best alternative for you.

Conclusion

Timing is critical under the tax law. Don't wait to determine how much - if any - of your distribution you'd like to roll over. Arranging with the plan administrator for a direct transfer will avoid the 20% federal income tax withholding requirement. Moreover, planning ahead will give you enough time to make the choices which will best meet your individual financial goals.

Handling a Retirement Plan Distribution

If you participate in a retirement plan at work, when you're ready to retire, or if you leave your present job to take another, you'll need to decide how to handle the retirement savings you've built over the years. Any distribution you receive from your employer's retirement plan will probably be an eligible rollover distribution. You also may have the option of receiving your retirement benefits as an annuity.

Eligible Rollover Distributions

These distributions essentially include every taxable distribution from a tax-qualified retirement plan except distributions that are a series of periodic payments paid at least annually:

Minimum required distributions, generally payable after age 70 ½ or after retirement, if later, are not eligible rollover distributions. Basically, you can do one of three things with an eligible rollover distribution. First, you can have your former employer's plan transfer your assets directly to an IRA or to your new employer's plan (if it accepts rollovers). This option is often the most tax advantageous. All federal income tax - and often state income tax, as well - is deferred until you begin withdrawals from the new plan or IRA.

Second, you can take your distribution in cash and pay income tax on the full amount in the year you receive the distribution. With this option, 20% of your distribution will be withheld for federal income taxes. The withheld portion will be applied toward your income tax for that year. If you're younger than 59 ½ when you receive the distribution, you also may have to pay a 10% early withdrawal penalty.

Third, you can take your distribution in cash and roll it over to an IRA or a new employer's plan within 60 days of receiving it. However, because you take possession of the distribution, the 20% withholding tax applies, even if you immediately roll over the full amount of the distribution, replacing the missing 20% with funds from another source. You can choose to roll over only the part of the distribution you actually receive (80%), but the withheld 20% will be considered a taxable distribution subject to income tax and the 10% penalty, if applicable.

Forward Averaging for Lump-sum Distributions

Your eligible rollover distribution may be considered a lump-sum distribution if it's made in one taxable year and represents your entire balance under the retirement plan (and certain other similar plans of your employer). If you are age 59 ½ or older when you receive a lump-sum distribution, you may be eligible to use a special forward averaging method to lower your taxes on the distribution. Forward averaging is a once-in-a-lifetime opportunity, so plan to use it to your best advantage.

One method, five-year forward averaging, was no longer available after 1999. Another method, ten-year forward averaging, may be available to you if you were born before January 1, 1936. You also may qualify for special capital gains treatment for a portion of your distribution attributable to pre-1974 contributions.

IRA Distributions

Money held in a rollover IRA or a traditional deductible IRA can be left there to grow tax deferred until April 1 of the year following the year you turn age 70 ½. Then you must begin taking minimum withdrawals, which will be taxed at ordinary income rates. However, you have some control when it comes to taking money out of your IRA. By naming your younger spouse as beneficiary of your IRA, you can reduce the amount of each required distribution - and your tax liability. You can achieve a similar result by naming a younger beneficiary who isn't your spouse, such as your child.

Look at All Your Options

The lower capital gains tax rates and the introduction of the Roth IRA have made tax planning for a retirement plan distribution more complicated than in the past, especially if you receive a payout before you retire. Many questions are raised. Some examples:

The answers will depend on a detailed analysis of your particular circumstances - how long you have until you retire, your investment goals, your risk tolerance, and your current and future tax picture. Obviously, everyone's situation is different and, as a result, there is no one "correct" response to any of these questions. Because of the multiple options available, though, it is important that you secure professional advice.

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