06/19/98

Parting Company

The rapid pace of today’s business often translates into careers with a tremendous amount of ebb and flow. What ever the reason -- resignation or termination -- most Americans will have a change in job status, usually several before experiencing the final and ultimate career move: retirement.

Those confronted with a career transition often face a decision that transcends the immediate concerns of finding new work, making ends meet or adjusting to retirement. That decision -- what to do with the funds in my company sponsored retirement plan-- can have a substantial long-term impact on personal financial well being.

Pension Plans
Workers who come to a career crossroads and who qualify for an annuitized pension -- plans that pay an unchanging monthly amount for life -- generally have fewer options than those covered by “lump sum” programs such as profit sharing and 401(k) type plans. However, annuitized pension plans do offer choices on your “pay-out”. These choices range from a “full” payment for one life (that of the employee) to reduced selections that will provide income for two lives including the serviving spouse. One pension maximization strategy is to take the full one life payment then purchase life insurance to provide for the spouse. This strategy puts you in control and could save your hard earned money.

Lump Sum Payments
There are several options for lump sum pay-out plans such as 401(k)’s and profit sharing plans. “Rollovers” or “transfers” of lump sums -- moving the distribution from the employer provided tax-deferred financial vehicle into another vehicle such as an IRA -- is a popular move. It remains popular because moving into an IRA gives you direct control over your money. This provides an extra measure of security. In addition, IRA accounts offer more flexibility today, including use of the funds for qualified educational expenses and up-to $10,000 for first time home purchase. Perhaps the greatest benefit could be converting the IRA-rollover into a Roth IRA to gain years of tax free growth. (Numerous factors must be taken into consideration to determine the advisability of converting to a Roth .)

The rollover option at retirement enables you to postpone income taxes on a lump sum payment until you begin taking IRA withdrawals. Direct lump sum distributions are subject to income taxes. However, if you are 59 1/2, and have been covered by the plan for 5-years, you can elect 5-year forward averaging. This strategy allows you to calculate the tax as if the lump sum were paid over five years.

Annuity Payment vs. Lump Sum at Retirement
Annuity payments provide a steady stream of income over your lifetime, but the unpaid portion could be lost if you and your spouse die prematurely. In contrast, a lump sum gives you full control of your assets making them available for your heirs. The challenge with the lump sum is to manage it wisely so as not to prematurely exhaust this resource. The tax considerations of each must also be weighed before making a final decision.

Tax Withholding
Tax withholding also is an important consideration. A person may be subject to a 20 percent withholding if the entire lump sum is not transferred or rolled-over directly from one custodian (plan) to another. So, a person’s relative distance to that 59 1/2 cutoff point -- and his ability to meet financial needs until then without touching the rollover -- becomes critical.

Those relatively close to age 59 1/2 may have other sources of income: from investments or a working spouse for instance. That would permit them to live comfortably and continue to enjoy the tax deferred growth of the rollover until it can be distributed without penalty or withholding tax.

Avoiding a Penalty
An individual who has a lump sum distribution may have needs -- a business opportunity or others -- that make taking part or all of the lump sum the thing to do; penalty, taxes and all. Withdrawing money from a qualified plan prior to age 591/2 is subject to a 10% income tax penalty. There are exceptions to this penalty. One exception applies when the distribution is a scheduled series of substantially equal payments for the life expectancy of the participant (and when elected, his or her named beneficiary).

The important point is that people who leave a company with a retirement investment must quickly learn and assess the options available to them. The options can represent good news for the future. But, many decisions, by law, must be exercised at the time of distribution or at the very latest, within 60 days.

Please send questions or comments to dcoffin46333@wradvisors.com.