Leaving Your Company
Are you thinking of retiring or leaving to work for another company? One of the most important decisions you will face is the question of what to do with your retirement plans. Generally, if the plan allows for current distribution of assets, you have several choices to consider.
Keep your money with the company’s retirement plan
Some employers allow you to keep your assets in the company’s retirement plan. If you are satisfied with the retirement plan’s investment selection and performance, this may be an attractive option. However, you should carefully review the investment choices, beneficiary choices and distribution options available to you. You may find that you have greater flexibility through a rollover to an IRA, a rollover to a new employer’s qualified retirement plan or a distribution into a taxable account.
Roll over the retirement plan assets into an IRA or a new employer’s qualified retirement plan
If the company you are leaving does not allow you to keep your assets in the retirement plan or you are looking for additional control and flexibility, you may want to consider rolling the distribution into an IRA. If you are starting a job with a new employer, you may also be able to roll the distribution into your new employer’s qualified plan. These choices will allow you to continue to reap the benefits of tax-deferred compounding with no immediate tax liability upon rollover.
Take a distribution
If you take a distribution, you may have to pay taxes on the distribution amount immediately. Distributions from a qualified plan before age 59 1/2 will be subject to a 10% penalty (unless you separated from service after attaining age 55) in addition to required income taxes. There are several strategies, however, that can be used to reduce the income-tax liability if the distribution qualifies as a lump-sum distribution.1 Reduce the tax liability on highly appreciated employer stock.Typically, distributions from retirement plans are taxed as ordinary income, which may reach up to 39.6%. However, if you have highly appreciated employer stock in the retirement plan, you may benefit from a special provision in the tax law: At time of sale, the appreciation of the employer stock is taxed at long-term capital-gain tax rates, which do not exceed 20%.
To take advantage of this provision, you must take a lump-sum distribution form you retirement plan and elect to pay income tax currently on the cost basis of the employer stock in the plan, no the current market value. The difference between the security’s cost basis and market value at the time of distribution is called the net unrealized appreciation (NUA). The NUA is taxable as a long-tern capital gain, no matter when the stock is sold after distribution.
Although the special treatment of the NUA applies only to lump-sum distributions, you do not have to keep the entire distribution. If part of your distribution consists of employer stock and part consists of mutual funds or cash, you may elect to receive all (or a portion of) the company stock and have the plan roll over the balance of the distribution to an IRA (or any other combination). This would be prevented from rolling over any portion of the flexibility to diversify your holdings on a tax-deferred basis.
The only time that you would be prevented from rolling over any portion of the distribution would occur if you wanted to qualify for special 10-year forward averaging. In evaluating the benefits of this choice, remember to consider your overall investment strategy, your lifestyle needs now and in the future, and the taxation of the future growth of these assets.
Take advantage of special 10-year forward averagingIf you were born before 1936, you may qualify for a special tax break that allows you to reduce the tax liability on a lump-sum distribution. To qualify for averaging, you would need to cash out everything in your retirement plan and not roll any of it into an IRA. Be sure to discuss with your tax adviser how this strategy may affect your overall investment portfolio.
Whatever distribution decision you make, additional factors should be considered. Always consult you tax and other financial advisers when evaluating your choices.
Keep your money with the company’s retirement plan
Some employers allow you to keep your assets in the company’s retirement plan. If you are satisfied with the retirement plan’s investment selection and performance, this may be an attractive option. However, you should carefully review the investment choices, beneficiary choices and distribution options available to you. You may find that you have greater flexibility through a rollover to an IRA, a rollover to a new employer’s qualified retirement plan or a distribution into a taxable account.
Roll over the retirement plan assets into an IRA or a new employer’s qualified retirement plan
If the company you are leaving does not allow you to keep your assets in the retirement plan or you are looking for additional control and flexibility, you may want to consider rolling the distribution into an IRA. If you are starting a job with a new employer, you may also be able to roll the distribution into your new employer’s qualified plan. These choices will allow you to continue to reap the benefits of tax-deferred compounding with no immediate tax liability upon rollover.
Take a distribution
If you take a distribution, you may have to pay taxes on the distribution amount immediately. Distributions from a qualified plan before age 59 1/2 will be subject to a 10% penalty (unless you separated from service after attaining age 55) in addition to required income taxes. There are several strategies, however, that can be used to reduce the income-tax liability if the distribution qualifies as a lump-sum distribution.1 Reduce the tax liability on highly appreciated employer stock.Typically, distributions from retirement plans are taxed as ordinary income, which may reach up to 39.6%. However, if you have highly appreciated employer stock in the retirement plan, you may benefit from a special provision in the tax law: At time of sale, the appreciation of the employer stock is taxed at long-term capital-gain tax rates, which do not exceed 20%.
To take advantage of this provision, you must take a lump-sum distribution form you retirement plan and elect to pay income tax currently on the cost basis of the employer stock in the plan, no the current market value. The difference between the security’s cost basis and market value at the time of distribution is called the net unrealized appreciation (NUA). The NUA is taxable as a long-tern capital gain, no matter when the stock is sold after distribution.
Although the special treatment of the NUA applies only to lump-sum distributions, you do not have to keep the entire distribution. If part of your distribution consists of employer stock and part consists of mutual funds or cash, you may elect to receive all (or a portion of) the company stock and have the plan roll over the balance of the distribution to an IRA (or any other combination). This would be prevented from rolling over any portion of the flexibility to diversify your holdings on a tax-deferred basis.
The only time that you would be prevented from rolling over any portion of the distribution would occur if you wanted to qualify for special 10-year forward averaging. In evaluating the benefits of this choice, remember to consider your overall investment strategy, your lifestyle needs now and in the future, and the taxation of the future growth of these assets.
Take advantage of special 10-year forward averagingIf you were born before 1936, you may qualify for a special tax break that allows you to reduce the tax liability on a lump-sum distribution. To qualify for averaging, you would need to cash out everything in your retirement plan and not roll any of it into an IRA. Be sure to discuss with your tax adviser how this strategy may affect your overall investment portfolio.
Whatever distribution decision you make, additional factors should be considered. Always consult you tax and other financial advisers when evaluating your choices.
There are other tax-cutting strategies in addition to those mentioned here. If you would like assistance in selecting tax-saving strategies that make the most sense in your situation, contact us today!
1 A lump –sum distribution is a distribution during a single taxable year of a participant’s entire account balance from all similar qualified retirement plans as a result of: separation form service (not applicable to owners of unincorporated businesses); death: disability (applies only to owners of unincorporated businesses) reaching age 59½.
Note: The distribution must be the first distribution as a result of the particular event.
2 Additionally, if you elect special averaging and you were in the plan prior to 1974, you can elect to have amounts attributable to pre-1974 participation taxed at a flat rate of 20%.
Note: The distribution must be the first distribution as a result of the particular event.
2 Additionally, if you elect special averaging and you were in the plan prior to 1974, you can elect to have amounts attributable to pre-1974 participation taxed at a flat rate of 20%.