 Personal
Finance Best Practices
Distribute the Wealth
Exploring Your
Retirement Plan Distribution Alternatives
Provided by: John Hamerlinck, UBS Financial Services Inc
Did you know that you may not have to retire to be
entitled to receive a distribution from an
employer-sponsored retirement plan, such as a 401(k),
profit sharing or defined benefit plan? You may, for
example, be entitled to a distribution if you are
leaving your company, if your company is terminating its
retirement plan, or if you are the beneficiary of a
deceased plan participant.
Regardless of when and why you become eligible for a
distribution from an employer-sponsored retirement plan,
what you decide to do next may well be one of the most
important financial decisions you will make.
Since your employer-sponsored retirement plan
distribution could represent the largest sum of money
you’ll ever receive at one time, it is important to do
your homework and evaluate your options before you
receive your distribution. It also makes sense to
consult with a financial advisor and tax advisor who can
provide recommendations to help you select the most
appropriate distribution alternative to fit your
individual circumstances.
Although the number of distribution alternatives
available to you will vary depending on the terms of
your specific plan, there are three common distribution
alternatives:
Annuitized Payments
Generally, when you elect an annuitized form of payment
from an employer-sponsored retirement plan, you will
receive a set monthly benefit amount either for your
life (or the joint life expectancy of you and your
spouse), or for a predetermined number of years.
Advantages
-
Provide a steady payment
stream for life intended to guarantee that you (and
potentially your spouse, if you are married) will not
outlive your retirement savings or provide steady
payments for a set amount of time.
-
Avoid the mandatory 20%
federal tax withholding on lump sum distributions (a
lower withholding rate will apply) and the 10% early
distribution penalty tax, if applicable.
-
You are only taxed on the
payments when you receive them, thus stretching out your
tax liability.
Disadvantages
-
You generally cannot elect
to modify the payment terms should your financial
circumstances change.
-
Depending on the terms of
the annuitized payment option, distributions often may
cease at your death, meaning that no further benefits
under the annuity contract would be paid to your heirs.
-
You bear the risk that the
purchasing power of your annuitized payments may not
keep up with inflation.
Lump Sum Distribution
Many plans permit the participant or beneficiary to
elect to have the entire benefit amount paid in the form
of a lump sum distribution. If you elect to take a lump
sum distribution, you will generally have to decide
between:
-
Paying taxes on part or all
of the lump sum distribution, or
-
Rolling over part or all of
the distribution to an IRA.
Advantages
Under certain circumstances,
taking a lump sum distribution may entitle you to
special tax treatment. For example, when all or part of
your lump sum distribution is comprised of employer
securities in a qualified plan, you may be eligible to
defer taxes on the portion of your distribution that
constitutes “net unrealized appreciation” (NUA), until
the stock is sold.
Disadvantages
-
If you are not eligible for
special tax treatment, your lump sum distribution
generally will be included with your other taxable
income. That means it could be subject to a federal tax
rate as high as 35%. State income taxes also generally
apply, which would make for an even higher immediate tax
burden.
-
You no longer benefit from
the tax-deferred growth of retirement assets.
-
You may exhaust all of these
assets during your lifetime.
Rolling Over Distributions
to an IRA
The third distribution
option available in many plans is to roll over all or
part of the amount of the retirement distribution to an
individual retirement account (IRA). By rolling over
some or all of the distribution to an IRA, you can defer
taxes on the amount rolled over and you will have the
ability to decide how to invest your money.
Advantages
-
The avoidance of what could
be a hefty, immediate tax burden, allowing you to invest
more money now.
-
The opportunity for faster
accumulation of your money over time through
tax-deferred growth.
-
The ability to invest your
retirement assets in almost any way you would like.
Disadvantages
-
You may exhaust all of these
assets during your lifetime.
-
For traditional IRAs, you
must begin taking annual required minimum distributions
(RMDs) after age 70˝.
Understanding the Mandatory
Federal Withholding Rules
Any portion of an eligible
rollover distribution that is paid directly to you is
subject to mandatory 20% federal income tax withholding.
In addition, if you are younger than 59˝ at the time of
distribution, you may be subject to a 10% early
distribution penalty tax in addition to ordinary income
taxes. (If you separate from service during the year you
become age 55, or later, however, and then receive a
distribution from your former employer's plan, the 10%
penalty tax will not apply. Other exceptions also
apply.)
Making the Choice that’s
Right for You
To help you decide how to
receive your distribution, your employer is required by
law to give you written notice describing your options,
including direct rollovers. At this point it would be
prudent to review the advantages and disadvantages of
each distribution option with your tax and financial
advisor and determine which option best meets your
personal needs and circumstances.
This article was provided by John Hamerlinck,
financial advisor for UBS Financial Services Inc.
Drawing on 20 years of management and financial
experience John works with business owners and
individuals that need sophisticated financial planning
and investment strategies. He recently joined UBS
Financial, one of the leading global financial firms. A
former Marine Corps veteran he holds a MBA from Lewis
University. You can contact John at 727-892-2516 or
www.ubs.com/fa/johnhamerlinck
This article is intended to provide a general discussion
of traditional and Roth IRAs. Neither UBS Financial
Services Inc. nor its financial advisors provide tax or
legal advice. You must consult with an attorney or tax
professional regarding your specific financial
situation.
1 Certain types of
distributions are exempt from the mandatory 20% tax
withholding.
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