LUMP SUM DISTRIBUTION TAXATION ALTERNATIVES
1. Elect to treat the entire distribution as ordinary income, add this income to all other sources of income, and pay taxes on the sum at regular tax rates. For most,…not a very advantageous or smart choice. Or,…
2. Pay taxes immediately on the taxable portion of the distribution pursuant to the Special 10-Year or 5-Year Averaging. If you were age 50 by January 1, 1986 you may elect either 10-Year or 5-Year one time. If you were not age 50 by January 1, 1986 then you are only entitled to a one time 5-Year averaging method.
3. If you were age 50 on January 1, 1986 then you may elect to separate the ordinary income and capital gains portions of the distribution and use Special 10-Year Averaging on the ordinary income portion. The taxable portion of the long-term capital gain is taxed at a 20% tax rate. Add the total of the two taxes for your total tax liability. (Watch out for triggering the Alternative Minimum Tax under this method.)
*4. Elect to rollover a portion or all of the qualified distribution, tax-free, to an IRA. Any remaining balance must be taxed along with other ordinary income.
AXIOM: The greater the need for income and resources from your Qualified Plan distribution in the early years following retirement, the greater the probability that you will be better off by taking applicable 5 or 10 year averaging. Conversely, the less likely you are to need a lot of cash or assets out of your Qualified Plan distribution in the early years following retirement then the more likely you are to be well served by utilizing the IRA rollover method. Accordingly, the need to use assets for large home improvements, expansions, a new home or other significant asset purchases or large expenditures in the early years after retirement will usually impinge upon the advisability to utilize the otherwise attractive IRA rollover option.
You have worked hard all your life for your retirement. The IRS, however, only provides you with a 60 day window of opportunity to decide which of the above alternatives you wish to use. Carefully calculate and compare the results of all your alternatives!
How to treat your lump sum distribution will be one of the most important decisions you will have to make for the rest of your life. Most any competent tax advisor can tell you which method will net you the least immediate income tax, but only a thorough objective analysis can help you determine which method actually produces the greatest economic benefit over your lifetime within the scope of your overall affairs.
*REMEMBER: You must make a direct transfer of your distribution to a pre-existing IRA in order to avoid the 20% TEFRA withholding tax!!!
IT IS EXTREMELY IMPORTANT TO SEEK QUALIFIED AND OBJECTIVE PROFESSIONAL GUIDANCE WHEN DEALING WITH YOUR LUMP SUM DISTRIBUTION. FOR FURTHER ASSISTANCE, E MAIL US YOUR INQUIRY AT firstname.lastname@example.org