In simple terms, a lump sum distribution can be described as "cashing out" of your company retirement plan. You are then faced with the decision of what to do with that distribution—either take it in the form of cash (check payable to you, the individual) or take it in the form of a rollover (check written to your new IRA custodian on your behalf). The best way to frame this decision is to begin with what NOT to do with your hard-earned and well-saved retirement plan money.
If you can possibly avoid it, you don't want to receive your distribution in the form of cash (check payable to you). Say that again out loud with me please. If you can possibly avoid it, you don't want to receive your distribution in the form of cash (check payable to you). Why you ask? Because you will trigger a taxable event like you have never seen or may ever see the rest of your life. Let's say you had a million dollars together with your pension and 401K and you elect to have those funds distributed to you. You have now jumped into the 37% tax bracket. Meaning that at worst you could pay up to 37% of that 1 million dollars straight to Uncle Sam.
Of course, the decision of what to do with your money is yours but when you receive a lump sum in cash, it means that you have lost the favorable tax treatment of the retirement savings. In different words, the distribution becomes taxable. This is because your 401(k) contributions and your pension, in most cases, were deducted from your paychecks on a pre-tax basis—they've never been taxed!!!
Rollin Your Lump Sum Distribution To An IRA
The best thing you can do with your retirement lump sum is to choose the IRA rollover option. This may still technically be a lump sum distribution but, instead of receiving a check payable to you, you will receive a check payable to your new IRA custodian. For example, if you open an IRA with 80/20 Financial Services, when you have terminated employment. When you receive your 401(k) and Pension distribution options, you will select the option that says something like, "Rollover to IRA" and the check will be written to your new IRA and not you.
***You may receive a ton paperwork to make this simple transaction. Don't worry about that 80/20 Financial Services can walk you through the process.
When done correctly the check will also say something like FBO [your name}. FBO means "for benefit of." When the rollover check is made payable to your new IRA, you do not constructively receive the money, which in tax accounting terms means you didn't receive the cash, and you DO NOT pay taxes on the distribution.
Now can you get out of paying taxes all together? Not a chance. However, there are strategies to reduce your tax burden on that amount. We can show you how to do that.
In summary, if you can avoid it at all do not have your lump sum distribution payable directly to you. Contact 80/20 Financial Services and let us help you formulate a plan to use that money in the most tax efficient ways possible.
You Need A Plan
A goal of retiring - without a plan to get there - is simply a plan to never retire. Retirement isn't some magical age. It's a dollar amount. If you're age 50 or over and still in the accumulation phase (pre-retirement) we can help you figure out where you need to go and how to get there. If you are retired or nearing retirement, we can create a plan which will outpace inflation and possibly leave a legacy to your family. The consultation is free and without obligation. Contact us to set up a consultation.
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80/20 Financial Services is an independent Registered Investment Advisory Firm. We help clients age 50 and over plan their retirement income and investment strategies. Contact us today for help with your retirement needs.