RETIREMENT PLAN DISTRIBUTION
As stated earlier, Defined Benefit Plans have been terminated or replaced since the 1980’s. Therefore, most of you have received or will be receiving your retirement or termination of employment distributions as a lump sum or as an account balance from a Defined Contribution Plan.
If you terminate and take your funds prior to age 59 1/2 you will be hit with an extra 10% Early Distribution Withdrawal. So let’s look at the various scenarios and the best ways to defer or reduce your taxable obligation.
I touched on these on the Taxation and Distributions page of this site but I want to elaborate on them more in this section.
Your lump sum distribution will have been derived from one or more of the following:
- Present lump sum value of your accrued monthly benefit from a Defined Benefit (DB) Plan
- Pre-Tax 401(k) Account
- 401(k) Employer Matching Account
- Post-Tax employee contribution Account
- Account Balance from a Defined Contribution Plan
Present Lump Sum Value
When you terminate from your employer and were covered under a DB plan, you will have accrued a monthly benefit payable at your Normal Retirement Date (NRD). The present lump sum value of this benefit is the amount of money, if left in the plan, would grow be required to pay for it at NRD, based on the actuarial assumptions defined by the plan.
If that lump sum value is $5,000 or less, the employer can make the decision to pay you out at termination. If the amount is greater than $5,000 than you can make one of the following decisions:
- Leave the money in the plan and take the monthly benefit at NRD.
It’s not preferred by the employee because he would have to inform the employer of his address every time he moved up until the point he decides to take distribution of his retirement funds. This also is not a preferred option by the employer because he would have to track you down if you never informed him of such.
- Take the lump sum value or the account balance (if from a DC plan) and cash the check. At the end of the year, you will receive a 1099-R. You will then have to claim the taxable portion of it on your tax return in which case it will be taxed as Ordinary Income. (The taxable amount consists of the entire amount minus any after-tax employee contributions you made.) In addition, when you take distribution of the lump sum or the account balance, a twenty percent is automatically deducted for federal income tax purposes.
- You can roll the taxable portion into an Individual Retirement Account and defer paying taxes on it until you cash it in or start taking distributions from it. The thinking here is that when you retire, you will be in a lower tax bracket than if you take it right away and employed by another company.
- If allowed by your next employer’s plan, you can roll it over to that plan as a Trustee-to-Trustee transaction.