You’ve worked, you’ve saved, and now you’re ready to start enjoying some of the money you’ve set aside for your retirement years. Planning ahead can help you make the most of your savings.
Weigh Your Options
If you participate in a traditional pension plan, you’ll generally have at least two payment choices: to collect benefits over your lifetime only or to collect a reduced monthly “joint and survivor” benefit for your life and the life of your spouse. Make this choice carefully.
While the simple lifetime benefit pays a larger sum each month, benefits stop at your death, potentially leaving your surviving spouse with insufficient income. With either option, the pension benefits you receive generally will have to be included in your income for tax purposes, so you will want to base your planning on projections of your income net of taxes.
401(k) plans and most other retirement savings plans sponsored by employers typically allow participants to withdraw their vested account balances in a lump sum at retirement. Your plan may provide additional payout options as well. As with a traditional pension, the money distributed from the plan is taxable to you in the year you receive it, except to the extent the distribution is attributable to after-tax contributions or is a qualified distribution from a designated Roth 401(k), 403(b), or 457 account.
Consider a Rollover
You can continue to defer taxes on an eligible distribution from a tax-deferred retirement savings plan by rolling the distribution over into an individual retirement account (IRA). A properly executed IRA rollover delays taxes on your savings and on IRA investment earnings until you take money out of the IRA.
Usually, the longer you can defer taxes, the better. In certain situations, however, it can make more sense to receive a plan distribution, even though you’ll have to pay taxes on the distribution that year.
For example, if a lump sum distribution will include appreciated company stock, taking the distribution may be your best alternative because you’ll be taxed only on the stock’s cost, not its appreciated value. Then, if you realize a gain on a subsequent sale of the stock, you’ll pay taxes on the gain at a favorable capital gains tax rate. Rolling the stock into an IRA means you’ll lose the benefit of the lower capital gains rate because all IRA distributions are taxed at your ordinary tax rate.
Take All Required Distributions
After you reach age 70½, you will have to begin taking annual required minimum distributions (RMDs) from your IRA. (This rule does not apply to a Roth IRA.) If you are retired and still have money in an employer-sponsored qualified plan when you reach age 70½, you’ll also have to start taking annual minimum distributions from that plan. If you continue to work for the plan sponsor after age 70½, minimum distributions do not have to be taken while you are still employed unless you are a 5% owner.
Failure to take a required minimum distribution can be costly. The IRS can assess a 50% excise tax on the amount of the shortfall. So, for example, a missed distribution of $10,000 could cost a forgetful taxpayer a $5,000 penalty.
Taxes may play a significant role in your retirement income planning. We’d be happy to review your situation with you.