P2251 Piecing Together Retirement, Peace of Mind -- Taking by vzm51964


                   Peace of Mind

           Taking Distributions From
            Tax-Deferred Retirement
                 Savings Plans

 Putting money into an employer’s retirement plan is just the first
step toward financial security in retirement. How you withdraw the
       money also requires your making decisions carefully.
   Taking Distributions from Tax-Deferred Retirement Savings Plans
If you are enrolled in an employ-     may allow hardship withdrawal,         used to avoid early distribution
er’s retirement savings plan such     but the amount you withdraw is         penalties. You can roll over a dis-
as a 401(k), 403(b), or a defined      subject to a 10-percent early dis-     tribution into a traditional IRA or
benefit pension plan, or if you        tribution penalty. A rollover in the   another qualified plan and contin-
have an IRA, SEP, or Keogh, you       first 2 years of a SIMPLE must          ue to defer taxes. Distributions
or your heirs must decide how to      be to another SIMPLE or a 25-          from tax-sheltered annuities
withdraw those funds. The rules       percent penalty applies.               (TSAs, also called 403(b) plans)
that apply and the choices you                                               can only be rolled over to a tradi-
have will vary with the type of       What about my deferred com-            tional IRA or another 403(b)
plan, the reason for the distribu-    pensation plan? Is there a             plan. Also, distributions from a
tion, and your age.                   penalty if I take my money out         Section 457 Deferred
                                      before age 591⁄2? Early withdraw-      Compensation plan can only be
This publication introduces some      al penalties do not apply to           transferred to another 457 plan.
of your choices and the consider-     Section 457 Deferred
ations involved in taking distribu-   Compensation Plans. These plans        How you set up the rollover has
tions from tax-deferred savings       make payments available at the         important consequences:
plans. It describes legal require-    earliest of the following situa-
ments employees and employers         tions:                                 Direct rollover: If you have the
must meet. Individual plans may                                              money transferred directly to a
                                      • when the participant reaches         traditional IRA or your new
also have other rules or options.       age 701⁄2,
Laws change and individual                                                   retirement plan, there is no with-
                                      • when the participant separates       holding and tax-deferred status is
employer’s plans may have               for service, or
slightly different choices. View                                             preserved.
                                      • when the participant is faced
this publication only as a guide.       with an “unforeseeable emer-         Indirect rollover: If you receive
                                        gency.”                              the funds yourself, 20 percent of
Age at Time of                                                               the distribution will be withheld
Distribution                                                                 for income taxes. You have 60
How distributions are taxed                                                  days to roll over the money to a
depends largely on your age at                                               traditional IRA or an employer’s
the time of the withdrawal (see                                              plan to avoid taxes and penalties.
Table 1). Some tax penalties                                                 If you roll over only the 80 per-
(called early distribution penalty)                                          cent you actually received, you
encourage you to leave your                                                  will be taxed and perhaps assess-
retirement savings untouched                                                 ed a penalty on the 20 percent
until you approach retirement                                                withheld for taxes. To avoid all
age. Other penalties ensure that      Types of Distributions                 taxes and penalties, you must
you make regular withdrawals in       Lump-Sum Distributions                 deposit the full amount of your
retirement so you do not defer        You may be able to take the value      old plan into your new account.
taxes indefinitely.                    of your employer’s retirement          You will have to replace the 20
                                      plan in a lump sum when you            percent that was withheld with
There are several exceptions to                                              other money and wait until you
                                      change jobs or when you retire.
the early distribution penalty but                                           file your income tax to seek a
                                      You can typically roll over lump
the specifics vary according to                                               refund of the amount withheld.
                                      sums or partial distributions if the
the type of plan. Table 2 summa-
                                      distribution is not part of a          Forward averaging is a way to
rizes major exceptions; hardship
                                      required minimum distribution or       calculate income tax on a lump-
withdrawal is not an exception.
                                      a series of equal distributions        sum distribution as if it had been
Profit sharing, or 401(k) plans,
 Table 1. Tax treatment of distributions, by age category
 Age (years)       Federal income tax treatment of distributions                            To avoid penalties*
 Under 59 ⁄2             Taxed at your marginal rate plus a 10-percent                      Roll over to an IRA or another employer’s
                         early distribution penalty; SIMPLE plans carry a                   plan or meet one of several exceptions (see
                         25-percent penalty on withdrawals made during                      Table 2). In the first 2 years of participation
                         first 2 years of participation.                                     in a SIMPLE plan, a rollover to a regular
                                                                                            IRA is not allowed.
 591⁄2 to 701⁄2          Taxed at your marginal rate; no penalties apply,
                         except for some 457 plans.
 701⁄2 and older         Taxed at your marginal rate. There’s a minimum                     Withdrawal required annually following year
                         required distribution based on life expectancy of                  in which you reach age 701⁄2; second
                         owner or joint life expectancy of owner and                        distribution by December 31 of the same
                         beneficiary.                                                        year. If you work past age 701⁄2, there may be
                                                                                            exceptions with employer plans.
*   Roth IRAs have different rules that determine whether distributions are tax-free. Distribution of the earnings on contributions to a Roth IRA
    must occur at least 5 years after the first contribution was made, and the distribution must also be made at these times:
    1) After age 591⁄2
    2) Death
    3) Disability
    4) Up to $10,000 toward a down payment on the purchase of your first home.

 Table 2. Distributions exempt from the 10-percent early distribution penalty
 Reason for distribution                                   Type of retirement plan
                                           Traditional IRA/SEP,              Tax-sheltered annuity or                 Qualified plan (for
                                           IRA/SIMPLE plan                   403(b)                                   example, 401(k) plan)

 Participant’s death                       Yes                               Yes                                      Yes
 Participant’s disability                  Yes                               Yes                                      Yes
 Participant’s separation from             N.A.                              Yes                                      Yes
 service after age 55
 Distributions part of a series            Yes                               Yes, but only following                  Yes, but only following
 of substantially equal                                                      separation from service                  separation from service
 periodic payments lasting at
 least 5 years or until age
 591⁄2, whichever is later
 Distribution to cover medical             Yes                               Yes                                      Yes
 expenses exceeding 7.5
 percent of adjusted gross
 Payment to alternate payee                Yes                               Yes                                      Yes
 under a Qualified Domestic
 Relations Order (QDRO)
 Down payment of first home                 Yes                               No                                       Yes
 (up to $10,000) or qualified
 higher education expenses
IRAs fall under different rules in a divorce situation than do qualified employment retirement plans; however, IRA money can be transferred to an
IRA for the spouse or ex-spouse without the 10-percent penalty.

received over a period of years.     • Choose direct rollovers (trans-     tive to taking a lump sum when
Individuals born before 1936 may       fers) rather than indirect          you retire. Some people who are
elect 10-year forward averaging        rollovers to avoid the 20 per-      under age 591⁄2 choose regular,
for lump-sum distributions; how-       cent withholding and the risk of    annual distributions as a way to
ever, you still must pay the taxes     missing the 60-day rollover         access their money and avoid the
all at once. The employee and the      period. Don’t risk losing the       early distribution penalty.
distribution must meet strict          money’s tax-deferred status and
requirements to qualify.               having to pay taxes on the full     Once you reach age 701⁄2, you are
                                       amount.                             required by the IRS to take mini-
 If I am eligible to use 10-         • If you took a loan from your        mum annual distributions based
 year averaging, is it better          retirement plan and you take a      on your life expectancy or the
 to do this or to take my              lump-sum distribution (even a       combined life expectancy of you
 money out slowly and pay              rollover), the amount of the        and your beneficiary. The IRS
 tax as I use the money?               loan that has not been repaid       publishes a table of life expectan-
                                       will be taxed as income and         cies for this purpose. Each year,
 Good question, but one that           may carry early withdrawal          you will divide the amount in
 must be answered on a case-           penalties.                          your account at the end of the
 by-case basis. The only hint        • Other things being equal, defer-    previous year by your life
 we can give is that if you can        ring taxes as long as possible is   expectancy to determine the min-
 take the money out over a             usually a wise financial deci-       imum distribution. You can
 longer period than 10 years,          sion. Delaying your distribu-       always withdraw more than the
 maybe even 15 or 20, it will          tions from tax-deferred savings     minimum amount, but you will
 probably serve you best to            will let them continue to grow      pay a stiff penalty if you with-
 leave the money in and pay            faster than if you withdrew the     draw less. If you work past age
 taxes as you need the money.          money. (After you pay taxes,        701⁄2, you may delay distributions
 On the other hand, if you             there is less to grow from.)        from your current employer’s
 expect to take it out in less         Some financial planners suggest      plans until you retire. This does
 than 10 years, whether you            you might like to weigh leaving     not apply to plans of previous
 average the lump-sum or not,          money in retirement accounts        employers or IRAs. Also, owners
 you may want to look care-            against the option of moving        of more than 5 percent of a com-
 fully at a 10-year averaging          money out and into investments      pany are not allowed to delay
 option.                               that would be taxed at lower        their minimum distributions past
                                       capital gains rates. To make a      age 701⁄2.
Financial Situations                   comparison, you must answer         Retirement-plan owners do not
                                       questions such as the following:    need to worry as much about
Once you roll over money from
                                     1) What would pulling out the         excess amounts accumulate in a
an employer’s plan into an IRA,
                                         money cost in current taxes?      retirement account. There is no
the funds fall under IRA rules for
                                     2) Where would I invest the           longer an excess distribution or
                                         money?                            excess accumulation tax on large
                                     3) What is current tax bracket        distributions (penalty was
                                         versus my projected tax           repealed). However, there is still
                                         bracket at a later date?          a need to do estate planning for
                                     4) If the fund is in the form of      large retirement accounts.
                                         company stock, am I better to
                                         take it now and only pay tax      You can calculate your life
                                         on the appreciated value?         expectancy two ways.

                                     Annual Distributions                  1) Under the term-certain
                                                                              method, use the Table of Life
                                     Retirement plans often offer             Expectancies to determine
                                     annual distributions as an alterna-
   your individual or joint-life       Extend Distributions                      Planning Tips
   expectancy in the first year.        It is possible on a joint-like distri-
   After that, you subtract one                                                  • Consider your health, life
                                       bution to use term certain for one          expectancy (given your
   year from that life expectancy      life and recalculation for the
   as each year passes. The risk                                                   family history, health, etc.),
                                       other. Some planners recommend              and anticipated needs to
   with term-certain life              doing this by recalculating the
   expectancy method is that                                                       decide whether to choose
                                       spouse’s life expectancy but not            annual distributions, a lump
   you might live longer than the      the owner’s. This enables you to
   distribution period. Proper                                                     sum, or an annuity. People
                                       extend the distribution and keep            are setting retirement goals
   planning can help you set           tax deferral going. At the same
   aside funds to prevent your                                                     that assume they will live to
                                       time, it sets a specific distribution        age 95 or older as the per-
   outliving your money. The           period other beneficiaries can use,
   advantage is that your heirs                                                    centage of people living
                                       even if you and your spouse die             past 95 is increasing dra-
   will only have to take distri-      before that period is over.
   butions as rapidly as you                                                       matically.
   were while you were living,                                                   • If you are working past age
   stretching their income tax                                                     701⁄2 and want to delay tak-
   burden over a number of                                                         ing distributions from your
   years.                                                                          current employer’s plan,
2) With the recalculation                                                          check with your employer
   method, each year you recal-                                                    to make sure the plan’s
   culate your life expectancy,                                                    rules allow the delay.
   and you recalculate that of
   your beneficiary if the                                                       Annuitized Payments
   beneficiary is your spouse.                                                   Rather than taking your money in
   Under this method, you go                                                    a lump sum or in annual pay-
   back to the table of life                                                    ments that will end when your
   expectancies. Your life                                                      investment is exhausted, you may
   expectancy decreases by less                                                 choose an annuity that guarantees
   than 1 year for each year you                                                you:
   live. As a result, your
                                         Planning Tips                           payments    for your life,
   required distributions in later
                                         • Remember: A minimum                   payments    for your life and the
   years will be smaller than
   those required under the term-          distribution is just that, min-        life of a named beneficiary,
                                           imum; you can always with-            the joint lifetime of you and a
   certain method.
                                           draw more. Balances in                 beneficiary, or
The advantage of recalculating is                                                for your lifetime with a guaran-
                                           your IRAs are added togeth-
that you can leave money in
                                           er to determine your mini-             teed number of payments, even
retirement accounts longer. The
                                           mum withdrawal, but you                if you die first, and
disadvantage is that the full bal-
                                           can take it all from one IRA          distribution for a set period of
ance of your account will be sub-
                                           or withdraw from several.              time.
ject to income tax in the year fol-
                                           You also have to take mini-          This is called annuitizing.
lowing your death if your spouse
                                           mum distributions from               Annuitized payment is the auto-
has already died. Some planners
                                           defined-contribution retire-          matic method of payment for
recommend recalculating the
                                           ment plans such as profit             defined-benefit plans (commonly
spouse’s life expectancy but not
                                           sharing and 401(k) and               known as “pensions”), unless you
the owner’s so the tax deferral
                                           403(b) plans.                        specifically make a different
can continue as long as possible,
while assuring that you can                                                     choice. Other retirement plans
stretch your distributions out until                                            may also offer an annuity as a
you die.                                                                        payment option.
Defined-benefit plans, some             annuity with pretax dollars. For     Factors that Affect Amount
defined-contribution plans, and        annuities bought outside a tax-      of Distribution
403(b) plans must offer annuities     deferred retirement plan, a formu-   Integration with Social Security
that provide survivorship benefits     la determines the portion of each
to spouses of plan participants,      annuity payment that is taxable,     Some qualified plans may sub-
when the participant retires! The     based on your investment in the      tract some of your Social
employer must offer a qualified        annuity. The retirement annuities    Security benefits when calculat-
joint and survivor annuity that       received by Civil Service            ing your plan benefit. This
will pay the spouse a specified        Retirement System participants       method results in higher pension
percent of the participant’s annu-    are treated for tax purposes in a    benefits for highly paid employ-
ity if the spouse survives the par-   similar fashion.                     ees whose earning were more
ticipant. The plan must offer a                                            than the maximum subject to
qualified preretirement survivor                                            Social Security tax. It means
                                        Planning Tips
annuity that will pay benefits to                                           smaller benefits for those who
                                       • Know your rights to your
the spouse if the participant dies                                         earned lower salaries and who
                                         spouse’s retirement savings
before retirement.                                                         will get a higher proportion of
                                         (and his or her rights to
                                                                           their salaries from Social
                                         yours), so you will not waive
The main advantage of a life                                               Security. Read your retirement
                                         this important property right
annuity is that you will not out-                                          plan’s summary description to
                                         unless you’ve given it seri-
live your money (not necessarily                                           see how it treats Social Security
                                         ous consideration.
true with period-certain annu-                                             benefits.
                                       • Beware of the effect of
ities); however, annuities carry                                           Social Security Offset
                                         inflation on your annuity
their own sets of risks. You may
                                         payments. If your payment         If you worked in a government
die early and get very little of
                                         does not increase with            position where your earnings
your investment back. Your
                                         inflation, an income that          were not subject to Social
spouse could die first, even after
                                         seems generous in the begin-      Security, the pension you get
you have chosen a joint and sur-
                                         ning erodes with inflation.        from that job may reduce the
vivor annuity with its smaller
                                       • Think twice before choosing       amount of Social Security you
monthly payments. Also, inflation
                                         an annuity as your invest-        can receive on your own work
over time will reduce the value of
                                         ment within an employer’s         record or from your spouse’s
your annual payments.
                                         plan. Taxes are already           work. For more detailed informa-
Do not confuse annuitizing your          deferred within your retire-      tion, ask the Social Security
retirement plan distribution with        ment plan. Buying an annu-        Administration for copies of two
the investment product called an         ity as the investment within      publications, Government
annuity. Annuities allow you to          a tax-deferred plan offers no     Pension Offset and A Pension
invest money for fixed or variable        additional tax benefit but         From Work Not Covered by
returns and defer taxes on those         will have additional costs        Social Security.
returns. You may buy an annuity          compared to other invest-         Distributions at Death
directly from an insurance com-          ment choices.
pany. An annuity may also be one                                           How the balance of your retire-
of your investment choices within                                          ment accounts is distributed after
your employer’s retirement plan.                                           your death depends on whom you
Distributions from annuities can                                           designate as your beneficiary,
be annuitized on a lump-sum, or                                            whether you had begun to take
other choices may be available.                                            distributions from the plan before
                                                                           your death, and whether you
Taxation of Annuities                                                      annuitized. For IRAs, it also
Under retirement plan annuities,                                           depends on the specific rules of
the full amount is taxable upon                                            the individual plan.
distribution if you bought the
Your beneficiary spouse                following your death, requiring         ments will be made for the
survives you:                         the balance of your account to be       remaining guaranteed time period
At your death, the spouse has the     distributed to your heirs in the        to your spouse or other bene-
option of rolling over the plan       year following your death and           ficiary.
balance to his or her own account     subjecting the full amount to
                                      income tax in that year.                If you chose a joint annuity and
and using his or her own age and                                              you die first, the survivor will
life expectancy to determine          The beneficiary is not                   receive the selected amount until
required distributions. If your       your spouse:                            his or her death. Typically, the
spouse does not roll over the         If you die before you had started       spouse’s payment is 50 percent,
account, the required distributions   taking distributions, the entire        60 percent, or some other per-
depend on whether you had             account must be distributed with-       centage of the payment received
begun taking distributions.           in 5 years of your death, or over       during the owner’s lifetime.
If you had not begun taking dis-      the life expectancy of the
tributions, your spouse must          beneficiary, with distributions          Taxes on Distributions
begin taking distributions by         beginning by December 31 of the         at Death
December 31 of the year follow-       year following your death. If you       Income taxes
ing the year you died or by           die after you start taking distribu-
                                                                              Your estate or beneficiary will
December 31 of the year in            tions, the beneficiary must take
                                                                              owe income taxes on any benefits
which you would have reached          distributions at least as fast as the
                                                                              for which you would have owed
age 701⁄2, whichever is later. If     schedule in effect when you died.
                                                                              income taxes. The funds will be
you had begun taking distribu-                                                taxed when they are distributed.
tions, your spouse must take dis-
                                                                              Estate taxes
tributions at least as fast as the
schedule in effect when you died.                                             Unless the total of your individ-
                                                                              ual estate—including your retire-
Your beneficiary spouse dies first:
                                                                              ment plan and any taxable gifts
If you had not yet begun distribu-                                            you have made in your lifetime—
tions when your spouse died, you                                              is more than the exclusion
may choose a new beneficiary,                                                  allowance equivalent, you will
then the rules in the next section                                            owe no federal estate tax. The
(the beneficiary is not your                                                   exclusion allowance equivalent is
spouse) will apply at your death.                                             $650,000 (rate in 2000),
                                                                              $700,000 in 2001, and is sched-
If you had already begun receiv-
                                                                              uled to reach $1,000,000 in 2006.
ing distributions before your
                                                                              The excess accumulation penalty
spouse died, what happens after
                                      You die while receiving annu-           on undistributed retirement sav-
your death depends on how you
                                      itized payments from a retirement       ings plans has been repealed.
calculated your life expectancy. If
you chose to use the term-certain     plan:
method, your distributions will       If you selected a single-life annu-
continue to your heirs or your        ity (your spouse must have
estate on the same schedule as        signed a written waiver of rights
when you were living.                 to a survivor’s annuity), no fur-
                                      ther benefits are payable at your
If you and your spouse chose to
recalculate your life expectancies,
your spouse’s life expectancy is      If you chose an annuity with a set
zero after his or her death, and      period of time and die before the
yours will also be zero in the year   “time certain” has ended, pay-

Making Decisions About                            Consult a professional if you                         Planning Tip
Your Distributions                                need help in making the choices
                                                  wisest for you and your situation.                    If income tax is the concern,
 Know   the laws so you can
                                                                                                        ask your tax advisor about
  avoid any penalties and unnec-                  Tax deferral on retirement funds                      preferred distribution sched-
  essary taxes.                                   is great for accumulating a retire-                   ules. Distribution planning is
 Plan ahead so you won’t be                      ment nest egg. However, if you                        technical and mistakes are
  forced to make a quick decision                 are extremely successful at accu-                     costly. Err on the side of cau-
  that you may not have thought                   mulating retirement funds, when                       tion, and check with your tax
  through.                                        you die, your family could be                         advisor if you have any ques-
Individual employer’s plans may                   surprised by the tax burden on                        tions.
have additional rules. Check your                 those tax-deferred funds.
employer’s plan to see what
                                                  Sophisticated planning may be in
options you will have.
                                                  order if you have a sizable estate
• Must you withdraw funds in a                    and are subject to a high income
  lump sum if you leave the                       tax rate and if funds in the
  employer before retirement                      account are designated to be
  age?                                            given to grandchildren. The
• Must you leave funds with your                  generation-skipping tax affects
  employer?                                       estates if you transfer more than
• What payment options are                        $1 million, as indexed, to heirs
  offered at retirement?                          two or more generations removed
                                                  from you.



By Jan Lukens, Extension Consumer Management Specialist. Adapted from a publication by Charlotte Crawford, University of
Illinois Extension Service.
Mississippi State University does not discriminate on the basis of race, color, religion, national origin, sex, age, disability, or veteran status.

Publication 2251
Extension Service of Mississippi State University, cooperating with U.S. Department of Agriculture. Published in furtherance of Acts
of Congress, May 8 and June 30, 1914. RONALD A. BROWN, Director                                                           (1M-5-00)

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