Financial & Wealth Services News

:: George G. Elkin, Managing Director, Financial & Wealth Services
631.923-1595 ext. 336
G. R. Reid Wealth Management Services, LLC  

 What Is the Most Tax-Efficient Way to Take a Distribution from a Retirement Plan?
 
If you receive a distribution from a qualified retirement plan, such as a 401(k), you need to consider whether to pay taxes now or to roll over the account to another tax-deferred plan. A correctly implemented rollover can avoid current taxes and allow the funds to continue accumulating tax deferred.
 
Paying Current Taxes with a Lump-Sum Distribution
 
If you decide to take a lump-sum distribution, income taxes are due on the total amount of the distribution and are due in the year in which you cash out. Employers are required to withhold 20 percent automatically from the check and apply it toward federal income taxes, so you will receive only 80 percent of your total vested value in the plan.
 
The advantage of a lump-sum distribution is that you can spend or invest the balance as you wish. The problem with this approach is parting with all those tax dollars. Income taxes on the total distribution are taxed at your marginal income tax rate. If the distribution is large, it could easily move you into a higher tax bracket. Distributions taken prior to age 59½ are subject to an additional 10% federal income tax penalty.
 

If you were born prior to 1936, there are two special options that can help reduce your tax burden on a lump sum.

 
The first special option, 10-year averaging, enables you to treat the distribution as if it were received in equal installments over a 10-year period. You then calculate your tax liability using the 1986 tax tables for a single filer.
 
The second option, capital gains tax treatment, allows you to have the pre-1974 portion of your distribution taxed at a flat rate of 20 percent. The balance can be taxed under 10-year averaging, if you qualify.
 
To qualify for either of these special options, you must have participated in the retirement plan for at least five years and you must be receiving a total distribution of your retirement account.
 
Note that these special tax treatments are one-time propositions for those born prior to 1936. Once you elect to use a special option, future distributions will be subject to ordinary income taxes.
 
 
Deferring Taxes with a Rollover
 
If you don’t qualify for the above options or don’t want to pay current taxes on your lump-sum distribution, you can roll the money into a traditional IRA.
 
If instead you choose a rollover from a tax-deferred plan to a Roth IRA, you must pay income taxes on the total amount converted in that tax year. However, future withdrawals of earnings from a Roth IRA are free of federal income tax as long as the account has been held for at least five tax years.
 
If you elect to use an IRA rollover, you can avoid potential tax and penalty problems by electing a direct trustee-to-trustee transfer; in other words, the money never passes through your hands. IRA rollovers must be completed within 60 days of the distribution to avoid current taxes and penalties.
 
An IRA rollover allows your retirement nest egg to continue compounding tax deferred. Remember that you must begin taking annual required minimum distributions (RMDs) from tax-deferred retirement plans after you turn 70½ (the first distribution must be taken no later than April 1 of the year after the year in which you reach age 70½). Failure to take RMDs subjects the funds that should have been withdrawn to a 50 percent federal income tax penalty.  
 
Of course, there is also the possibility that you may be able to keep the funds with your former employer, if allowed by your plan.
 
Before you decide which method to take for distributions from a qualified retirement plan, it would be prudent to consult with a professional tax advisor. 


Visit our website:  G.R. Reid Wealth Management Services, LLC


George Elkin is a Registered Representative offering Securities through American Portfolios Financial Services, Inc. Member: FINRA, SIPC. Investment Advisory products/services are offered through American Portfolios Advisors Inc., an SEC Registered Investment Advisor. G.R. Reid Consulting Services, LLC  is not a registered investment advisor and is independent of American Portfolios Financial Services Inc. and American Portfolios Advisors Inc. Unless specifically stated otherwise, the written advice in this memorandum or its attachments is not intended or written to be used for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code. Information is time sensitive, educational in nature, and not intended as investment advice or solicitation of any security.

This material was written and prepared by Emerald.

Accounting & Tax News

:: Ray Floch, CPA, Partner
631.425.1800 ext. 312
G.R. Reid Associates, LLP

Consider Carefully If You Should Work After “Retirement.”

Since an individual's excess earnings may affect his own benefits as well as those that are payable to his dependents, while the earnings of a dependent or survivor reduce only the social security check of that dependent or survivor, before considering any type of work, an individual should determine the expenses of working. The individual would have to pay social security or self-employment taxes on those earnings—even though he is receiving social security benefits. He also may be required to pay federal income taxes on that income, depending on his total income. An individual should remember that, above a certain level of income, a portion of any social security benefits is taxed. Also important are direct expenses, such as the cost of transportation, meals, clothing, etc.

An individual also should remember that if he earns more than $14,160 in 2011 (unchanged from 2010) and is between age 62 and full social security retirement age (subject to the special rule for individuals reaching full social security retirement age in 2010), he must forfeit $1 in benefits for each $2 of excess earnings—a 50 percent reduction in earnings over $14,160 (or $1,180 per month). Individuals who reach full social security retirement age in 2011 forfeit $1 in benefits for each $3 in excess benefits for each month before reaching full social security retirement age; the income level for these individuals is $37,680 or $3,140 per month (both unchanged from 2010).

Individuals need to face these facts head-on; however, the offset of earnings against early retirement benefits is merely a factor to consider in determining whether to continue to do least some paid work after electing to receive early retirement benefits. The offset should not prevent an individual from working who needs or chooses to do so. If an individual is collecting benefits and knows that his earnings will exceed the annual limit, he should notify his local Social Security Administration (SSA) office. By doing so, benefits can be withheld currently instead of the individual having to repay them later. As soon as his earnings drop, the benefit payments can start in full again. He must file a report of his calendar year earnings by April 15 of the following year. The report form is available at any SSA office and is filed with SSA, not IRS.

An additional point to remember about continuing to work: More earnings may help raise an individual's social security retirement benefit. If an individual has worked all of his life in social-security covered employment, higher current earnings may substitute for earlier lower earnings years. If close to the minimum years of coverage, additional years of work raise the amount of benefits payable even more directly. SSA runs an automatic process to check if the latest year of earnings turns out to be one of the highest 35 years and will refigure the benefit and pay any increase due. This process usually completed by October of the following year. For example, by October 2011, a beneficiary would get an increase for 2010 earnings if those earnings raised the benefit due; the increase would be retroactive to January 2011.