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Glossary
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- Options abound for re-investing
profits-sharing plans, pensions
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Are you thinking about
changing jobs or retiring? If you expect to receive a distribution
from you employer’s pension, profit sharing, 401(k), 403(B) or other
tax-deferred retirement plan, here is some important information you
need to know:
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Your employer is required by law to automatically withhold 20
percent of your distribution for income tax purposes unless you elect
to roll over your distributions, including those due to termination of
employment. (Certain distributions are exempt from the 20 percent tax
withholding – consult your tax adviser for more information.)
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If you take your distribution before you reach age 59 ½ or as
a result of separating from service before age 55, you might be
subject to an additional 10 percent tax penalty for an early
withdrawal. Since your
qualified retirement plan distribution could represent the largest sum
of money you will ever receive at one time, it is important to
evaluate the distribution options available to you. Although the
number of distribution alternatives varies depending on the terms of
the specific qualified plan, you generally have the following two
choices: a distribution made payable to you, or a direct rollover to
an IRA or other qualified plan.
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- Distribution made payable
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If you decide that you
need the money now, and the distribution is made payable to you, you
are subject to the 20 percent tax withholding.
This means that you would receive a check for 80 percent of the
account balance. The
withholding taxes would be sent to the IRS and credited towards your
federal income taxes. After
you receive your distribution, if you change your mind and decide that
you would like to roll it over into an IRA or an eligible qualified
plan of your new employer, the following options are available.
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Roll over the 80 percent
that you received within 60 days.
The remaining 20 percent would be considered taxable income.
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Roll over 100 percent of the
amount of the distribution within 60 days by contributing cash to
replace the 20 percent that was withheld.
That 20 percent would still be credited towards your federal
income taxes.
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- Direct rollovers
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Rather than directly
receiving the distribution, you have the option to elect to have all
or part of your eligible distribution rolled over from your
company’s retirement plan to an IRA, or to your new employer’s
plan. Direct rollovers
have two distinct advantages over taking distributions directly:
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The avoidance of what could be a hefty, immediate tax burden,
allowing you to invest more money now.
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The opportunity for faster accumulation of your money over time
through tax-deferred growth.
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- Direct rollover to an IRA
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A Rollover IRA is a
traditional IRA that has been established for the sole purpose of
receiving a distribution from a qualified plan.
After receiving written notice from your employer describing
your options, you will be given time to establish a Rollover IRA with
the financial institution of your choice and to give your employer
instructions for completing the direct rollover.
You should contact the institution where your IRA will be
established to obtain the necessary paperwork and instructions on
forwarding the distribution. In
some cases, your company will be able to directly transfer the assets
to the IRA. In other cases, the company will prepare a check.
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Be sure to instruct the
company to make the check payable to the IRA custodian and not to you
in order to avoid the 20 percent withholding. When you complete a direct rollover, your employer will
report the direct rollover distribution to the IRS on Form 1099-R and
your IRA trustee or custodian will report the offsetting direct
rollover contribution on Form 5498.
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- Direct rollover to another qualified
retirement plan
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If your distribution is the
result of your changing jobs and your new employer has a qualified
retirement plan, ask the administrator of the plan if rollover
deposits are accepted. If
they are, you can have your former employer make the check payable to
the new employer’s plan trustee.
If the plan does not accept rollover deposits, you can initiate
a direct rollover to an IRA as described above.
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- Making your decision
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The rules regarding
distributions can be complex and contain many other conditions and
exceptions that could not be discussed in this article.
The distribution option you choose likely will depend on your
current financial situation and your future needs and goals.
Consult a financial advisor, as well as tax and legal advisors
to help you sort through the distribution options, and assist you in
developing an investment strategy to meet your retirement objectives.
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