Making the right distribution decision

The contributions made on your behalf to your employer’s retirement plan grow tax deferred. But if you leave your employer, you may receive a distribution of some or all of your retirement plan assets. Without careful planning, this money may be subject to unnecessary or untimely income tax treatment.

Your distribution decision ... which is the right choice?

Making an informed decision requires an understanding of your alternatives. Should you roll over to an IRA* or pay the tax now? Is the Roth IRA an alternative to consider?

Which road will you take?

If you are receiving a lump-sum distribution from your employer’s retirement plan, the chart below helps answer two of the most common questions asked by people in this situation.

What is the tax treatment?
Is it eligible for an IRA rollover?

* All references herein to "IRA" are traditional IRA unless otherwise stated.

• Which road should YOU take?
• Taking the money now
• Deferring all taxes until later
• Pay the tax now ... take tax-free distributions later

Which road should you take?

If you are en route to retirement or are changing jobs, there are important decisions you need to make... and sooner than you may think. How will you preserve the retirement funds you have accumulated over an entire career? They will help provide the income stream for your future.

What decisions need to be made?

• Do you want the money now? If you want to take all or part of your money in cash, you will pay ordinary income taxes – and probably a 10% penalty – on whatever portion is not rolled directly into an individual retirement account or another employer’s plan.
• Do you want to pay the tax later? If you want to keep deferring taxes and maintain control over your money, you can transfer your accumulated assets directly from the current plan into an IRA.
• Do you want to pay a one-time tax today? If you want to take advantage of the Roth IRA and ultimately withdraw your money tax free, you must first roll over the assets from your employer’s plan into a traditional IRA.
• Your individual circumstances will determine which option is right for you. The information provided here is merely an overview. We recommend that you review your personal situation with us and your tax advisor.

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Taking the money now

If you want the money now, it will cost you. By law, 20% will be withheld toward federal income taxes on whatever you receive. So right away you will have lost the use of one-fifth of your retirement assets. If you are not at least age 59 1/2, disabled, or leaving your job after the age of 55, you are subject to an additional 10% federal tax as a premature withdrawal penalty. State taxes may also apply.

Forward averaging.

If you were born before January 1, 1936, you may use 10-year forward averaging. Forward averaging can only be used once in your lifetime, so consideration should be given as to the possibility of a future lump-sum distribution. It cannot be used on any distributions representing after-tax contributions, but can be used on the earnings from such contributions. Distributions must meet these requirements to be eligible for forward averaging treatment:

• They must come from a qualified pension or profit sharing plan.
• They must be paid because you have left your job, become disabled* or died.
• Distributions from plans that were terminated by the employer are not eligible unless you have reached age 59½.
• The full distribution amount from all plans must be paid to you within one calendar year.
• You must have participated in your company's retirement plan for five years or more.

* Payment due to disability applies only to self-employed persons.

Employer stock distribution options

Participants who have highly appreciated employer stock should consider taking an in-kind distribution of the stock, instead of rolling it over to an IRA. The ordinary income tax upon distribution is paid on the cost basis of the stock, which is the price at which the stock was allocated to the participant. The appreciation in the stock is taxed as a capital gain when the stock is ultimately sold. The advantage to this strategy is the difference between ordinary income tax rates and capital gain rates.

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Deferring all taxes until later

If you want to avoid any current taxes, you must have your retirement plan money transferred directly into an IRA (referred to as a "direct rollover"), leave it in your former employer’s plan or transfer it directly into a new employer’s plan.

It is important to understand the distribution options and procedures of your former employer’s plan. If you want to avoid the 20% withholding tax, you must specifically request a direct rollover. The withholding tax is required if you physically take possession of the distribution amount, even if you intend to roll it over to an IRA.

Summary of an IRA rollover

Benefits

• No current taxes due on rollover amount.
• Assets grow tax free inside IRA.

How it works:

• To avoid the 20% withholding tax on qualified plan distributions, you must elect a direct rollover to the IRA before you receive your distribution check.
• If you do not elect a direct rollover, 20% will be withheld upon distribution. You can still avoid taxes on the distribution by rolling over to an IRA within 60 days of receipt of your distribution. (Example: Joe takes distribution of his $100,000 employer profit sharing account when he changes jobs. His former employer sends $20,000 to the IRS and a check to Joe for $80,000. If Joe can access $20,000 from another source, the entire $100,000 can be rolled over to an IRA, thus avoiding any tax consequence on the distribution. When he files his tax return, the $20,000 that was withheld would, in effect, be refunded.)
• Stock received in a distribution can be rolled over - or sold and the proceeds rolled over.

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Pay the tax now ... take tax-free distributions later

The Taxpayer Relief Act of 1997 introduced the Roth IRA. Investments in a Roth IRA grow tax free and are distributed tax free under certain conditions.

A distribution from a qualified pension or profit sharing plan may not be rolled over into a Roth IRA. However, an individual can roll over a distribution from his or her employer's qualified plan into a traditional IRA and then elect to convert or roll over that IRA into a Roth IRA.

The advantage to this strategy is that after the tax is paid on the initial distribution from the IRA, there is no further tax, as long as the money stays in the Roth IRA a minimum of five years and the person reaches age 59 1/2, dies or the money is used for a qualified first time home purchase.

Key provisions of the Roth IRA. Distributions from a traditional IRA may be rolled over or converted to a Roth IRA if an individual's adjusted gross income (AGI) is not more than $100,000 (same for married or single) in the year of the rollover or conversion. An individual can choose to roll over or convert any portion of his or her traditional IRA to a Roth IRA.

The distribution amount is treated as ordinary income, but is not included as income for purposes of determining the $100,000 AGI limit. For purposes of conversation, a distribution from a traditional IRA being rolled over or converted into a Roth IRA is not subject to the 10% premature withdrawal penalty tax imposed on withdrawals from traditional IRAs before age 59½.

Let us help you take the next step

Although the information presented here helps give you a general understanding of the options available to you for your distribution, it is by no means a substitute for consulting with us to receive professional assistance. Please contact us today to discuss how to make the right distribution decision.

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