Retirement Lump Sum Payouts
Whether you are changing jobs or are lucky enough to retire early, there will be several opportunities during your lifetime when you are presented with making decisions concerning a lump sum retirement payout. This might occur when you change jobs, and hopefully, you'll roll the money over into an IRA or into your new employer's 401(k) plan at work.
This roll-over will continue the tax deferred growth of the funds, as well as guaranteeing you won't have a penalty and income tax liability on the withdrawal until you actually retire.
So when we talk about lump sum payouts, we're actually talking about the requirement or ability to take all your retirement funds from your employer's plan when you actually retire. Although this might be a little premature for a discussion with people in their 40s and 50s, many people have the goal to retire at age 55. Maybe you're one of the lucky ones who can do this.
Of course, you don't want to take all the funds out of a retirement plan creating a horrendous tax liability. If you are required to or you want to take out the funds from the retirement plan, roll-over all the funds into an IRA held at your local bank or with a brokerage firm, then you can start to withdraw the funds needed to retire.
The rollover must be made from the company's plan directly to the new account. If you don't have a “trustee to trustee” transfer, your employer is required to withhold 20 percent in taxes. This money is held by the IRS until you file your return in April and is considered a distribution. Ouch! The withholding and withdrawals can easily be avoided by rolling over the funds directly to the new investment firm.
Once you've rolled the funds into a new account, you can set up monthly withdrawals or keep it building until you are ready to begin distributions at 59 1⁄2 or later. The withdrawals depend on whether you have enough money on which to live without using the retirement funds.
When your retirement account was managed within your employer's plan, your employer was watching the funds and making certain the fund choices were good. Once you leave their plan, the choices are yours and the problems begin.
First, are you going to handle investing the money yourself within a family of funds, a brokerage account, or are you going to find a financial advisor who will guide you through the process? It's frustrating to see persons with $230,000 in retirement money hook up with a commission financial adviser who gets paid 5 percent of the value of the retirement account (that's over $10,000) just to guide you into investing your funds within an annuity or mutual fund family.
So look for a financial adviser who gets paid on an hourly basis to help you find a good place to invest your money.
There are pros and cons to investing in an annuity, but qualified retirement money should not go into an IRA annuity. IRAs are already sheltered from tax liability until withdrawn (the funds are sheltered from tax analogous to being sheltered by an umbrella). Annuities are also sheltered, but it's like putting an umbrella over an umbrella and as you can only imagine, the internal fees of the IRA annuity are higher than just a mutual fund IRA.
An annuity is a contract between an insurance company and an individual that will provide periodic payments to the individual, or to a designated beneficiary, in return for an investment. Usually, the annuity agrees to provide payments to the purchaser (known as the annuitant) beginning at some future date. An IRA annuity is somewhat different because it must follow the IRA payout rules rather than the annuity rules. So if you have a lump sum payout, set up an IRA not an IRA annuity.
We've all been taught since we've been kids that you can't withdraw from an IRA until you are 59 1⁄2. Well, as usual, the IRA has exceptions to their rules. So if you retire at 55, and want to use your retirement funds, you can withdraw money from an IRA within a very limited set of rules. The IRS requires that you take a fixed periodic payment for at least 5 years or until you are 59 1⁄2, whichever comes later.
That sounds like Greek, so we'll give you some examples to clarify the rules. This is a very obscure and little known rule and it's important for people who are forced to retire early or want to retire early. No one wants to pay more tax than they have to and no one wants to pay a 10 percent penalty on retirement money withdrawn before they are 59 1⁄2.
If you retire at 57 and set up a monthly payout for five years, you won't be able to change your payout until after age 62 since you need to take the fixed payment for 5 years. But if you retire at 52, you'll need to continue the fixed payment for 71⁄2 years until your 59 1⁄2 to guarantee you aren't penalized for the withdrawals. Of course, the funds are taxed, but not penalized.
The monthly payout is calculated based on your life expectancy, similar to a minimum required distribution, so visit with a CPA before you use this interesting option.
Also remember when you rollover funds, that the total can be divided into separate accounts and the funds used differently. If you want to set up fixed payments, know they cannot be changed without creating a tax nightmare. Not once during the entire time period can you change the payout, so if you need more money, you'll be penalized for all the years you've been taking withdrawals. Thus, it's best to have another fund, either with other retirement money or preferably with nonretirement money from which to purchase a car or other needs.
The following are things to remember with a lump sum payout:
Roll-over, don't withdraw your lump sum payout to prevent possible penalties, and certainly income taxation on the funds.
Use a “trustee to trustee” transfer of funds to prevent income tax withholding. This continues deferral on the funds until withdrawn.
Withdrawals before age 591⁄2 can be accomplished without a 10 percent penalty, but within strict guidelines.
Review whether to stay with the same investment firm as your employer is using, or look for a fee only financial advisor to guide you where to move your money.
The total retirement fund can be rolled into various retirement accounts, to be used differently.
An IRA annuity has greater internal costs than just an IRA or just annuity.
Excerpted from The Complete Idiot's Guide to Personal Finance in Your 40s and 50s © 2002 by Sarah Young Fisher and Susan Shelly. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.
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