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ABOUT FINANCE
How to Take Your Lumps ... Or Maybe Not
Michael L. Brunner
Many companies today are giving their employees the option
of taking a "lump sum" distribution from their retirement
plans when they leave a company or retire. Having what may
be a substantial sum of money all at once can give you a false
sense of wealth. You now have to deal with such issues as
taxation, your continued plans for retirement and your prospects
for employment that could easily cut into your nest egg.
For many people, receiving a lump-sum distribution can be
a temptation. You may think you "deserve" that new
car, an expensive vacation or, perhaps you want to be generous
with gifts to family members.
You may be under the misconception that the sum alone is large
enough to support you during retirement. Or, if you are not
yet ready for retirement, you may rationalize that you still
have the opportunity to build up another retirement fund at
another company.
These reactions are typical. According to a 2001 report from
the American Association of Retired Persons, fully 60 percent
of 401(k) participants who change jobs take cash payments
rather than roll their balances over into their new employers'
plan or an IRA, jeopardizing their long-term economic security.
There seems to be little recognition among the general population
that a lump-sum distribution comprises funds that were built
up over the years and should remain earmarked for retirement.
One pervasive myth is that retirement represents just a small
portion of your life. The reality is that we're all going
to live longer on average than our grandparents did.
The National Center for Health Statistics reveals that Americans
can expect to live nearly 20 years or even longer after they
retire. This is not bad news; it simply means that the dollars
you save during your working years must sustain you during
your retirement years - more years than many of us may have
been anticipating.
What steps can you take to better prepare for a secure and
comfortable retirement?
Since the largest single source of retirement funds will most
likely come from your company's retirement plan, such as a
401(k), it's important to understand your options when you
receive a lump-sum distribution. Basically, there are four
alternatives available to you:
You may elect a direct rollover into an IRA.
You may take receipt of the funds and then perform
a rollover within 60 days.
You may roll over a portion of the funds.
You may elect to receive the funds and pay current taxes
on the distribution.
If you transfer your distribution to an IRA or another qualified
plan, your entire distribution will continue to grow tax
deferred.
If you take your distribution and roll it over within 60
days, you will have to add back the 20 percent your employer
was required to withhold in order for your entire distribution
to continue growing tax deferred.
If you roll over part of your distribution and take the
remainder, you will defer taxes on the portion you roll
over - and pay taxes - and possibly incur a penalty for
early withdrawal if you are under age 59½, on the
portion you take.
And if you take your entire distribution in cash, you will
pay taxes on the distribution (unless you qualify for a
preferential tax treatment) and will probably pay a 10-percent
tax penalty if you are under age 59½.
The tax laws surrounding lump-sum distributions can be complex.
Retirement planning is a lifelong process, and you will
likely encounter equally complicated decisions regarding
distributions from your IRAs and perhaps additional lump-sum
distributions throughout your lifetime.
How can you manage this distribution process effectively?
A prudent course is to seek professional help from a tax
advisor, estate-planning attorney and a financial consultant
before making any decision, which in many cases could be
irrevocable.
Once you run your own numbers and match them with your present
situation and future goals, then you can see for yourself
what choice is best in your individual circumstances. The
bottom line is that your future, and that of your family,
depends on the intelligent retirement planning decisions
you make today to preserve the value of your lump-sum distributions.
Michael L. Brunner, CFP, is senior
vice president-investments, portfolio manager and financial
consultant for Salomon Smith Barney Inc. in Houston.
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