February 16, 2011
By Staff Reporter
My husband has worked for his company for more than 20 years and was recently offered an early retirement package. I was wondering if you could give us some idea of the main issues we should consider?
– J. McA., Newark
By Kevin FitzGerald
While retirement is an enjoyable time for many, it can also cause concern about important financial decisions. Probably one of the biggest decisions you’ll have to make centers on the distribution of your company’s retirement plan.
How you choose to receive your payouts is crucial because it determines your financial security during retirement, as well as the security of your survivors. Since accrued retirement benefits are among the largest assets most people will ever see, it’s critical to give this decision considerable thought. The following outlines the options you have for receiving these assets and reviews some of the pros and cons associated with each.
Annuity payout
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One option for your pension benefits is to take an annuity. An annuity is a continuous stream of income paid for a specified period of time, often designated as a single or joint lifetime. A single-life annuity pays a monthly sum for as long as you live but doesn’t provide for your survivors after your death. A joint-and-survivor annuity pays out less per month, but in the event of your death, it continues to pay a beneficiary a portion of your monthly allotment for his or her life. For example, a joint-and-survivor annuity might pay you $300 per month for as long as you live; upon your death, if your spouse survives you, he or she might receive $150 a month for life. This is known as a joint annuity with a 50 percent survivor benefit.
The annuity’s chief advantage is a guaranteed payment, and some plans also provide for cost of living increases, thereby providing an inflation hedge. In addition, if you exceed the actual estimates for your life expectancy, you could come out ahead. What an annuity doesn’t offer is special tax treatment choices, investment control, income flexibility or assets for your heirs.
Lump-sum distributions
Another option available in some plans is a lump-sum distribution. If you choose this option you would receive your retirement benefits immediately in a single payment. Taking a lump-sum distribution gives you greater flexibility in your investment decisions, along with the potential to earn a higher return. However, the lump sum distribution imposes more responsibility on the recipient to invest wisely, because poor investment choices could mean that your lump-sum money could be depleted during your lifetime.
If you select the lump-sum distribution option, there are additional choices to consider. For example, do you want to pay the tax due right away? (If so, you may be eligible for special tax treatments.) Or do you want to defer taxation by rolling the money over to an individual retirement account (IRA)?
The tax question
Your employer is required by law to withhold an amount equal to 20 percent of the distributions unless you elect to roll the distribution directly into an IRA or other qualified retirement plan. The law impacts almost all distributions, including those due to termination of employment.
Any part of your plan distribution that is paid directly to you is subject to the 20 percent tax withholding. This means that you would receive a check for 80 percent of your account balance. The withholding taxes would be sent to the IRS and credited against your federal income taxes. (If you take a distribution before age 59-1/2, you may also be subject to an additional 10% tax penalty for an early withdrawal.)
If you do roll over your lump-sum distribution into an IRA rollover or another qualified retirement plan, you can defer taxes. The advantage of this is that you’ll wind up with more money to invest because the tax bite won’t affect your distribution immediately. Discuss the implications of your decision and evaluate tax-saving strategies with a professional.
The investment question
If you select the IRA rollover, you can choose from a wide variety of investments, including government securities, CDs, money market funds, stocks, bonds, mutual funds and unit investment trusts. There is an investment for each type of investor, from the conservative to the aggressive.
Deciding what to do with your retirement plan distribution can be very confusing, but professional assistance is available. As you plan for retirement, two professionals will become increasingly valuable to you: your tax advisor and your investment executive.
Your tax advisor can help you work through the finer details of the tax laws and determine the best option for your individual situation regarding taxation on your lump-sum distribution. Your investment executive can help you choose investments for your lump-sum distribution that best suit your financial objectives.
Remember, the best way to cope with early retirement is to be prepared, and it’s never too soon to start thinking about — and planning for — your golden years.