Taking Your Lumps-or Not

By Michael L. Brunner

Receiving a lump-sum distribution can be tempting. 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 AARP, 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 twenty 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: 1) You may elect a direct rollover into an IRA. If you transfer your distribution to an IRA or another qualified plan, your entire distribution will continue to grow tax deferred. 2) You may take receipt of the funds and then perform a rollover within 60 days. 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. 3) You may roll over a portion of the funds. 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 591/2 on the portion you take. 4) You may elect to receive the funds and pay current taxes on the distribution. 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.

The tax laws surrounding lump-sum distributions can be complex. Retirement planning is a lifelong process. 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.