When you retire from your cooperative you have several options on how to receive your R&S pension and your 401k. You can take it in a series of payments, you can take it as a lump sum distribution or you can do a combination of both. For those of you interested in the lump sum distribution, I want to make sure you avoid a critical mistake that I have seen retirees make.
In simple terms, a lump sum distribution can be described as "cashing out" of your cooperative's retirement plan. You are then faced with the decision of what to do with that distribution. You can 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).
Which should you choose?
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 Aunt Iris (IRS).
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 100% 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!!!
You can rollover 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. An IRA is an Individual Retirement Account in your name. 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 your behalf. When you receive your 401k 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 to you.
*You may receive a ton of 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 FBO [your name}. FBO means "for benefit of." When the rollover check is made payable to your new IRA you do not physically 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
At 80/20 Financial Services, we are retirement planners and we specialize in working with electric cooperative employees. We can help you answer questions like:
I started this firm specifically to help electric cooperative employees with retirement planning. I worked for an electric cooperative for 11 years and I know your profession and benefit plans better than any other financial advisor will. You have excellent retirement benefits available to you. I can help you optimize those benefits while creating a retirement income and investing plan that aligns with your retirement goals.
Contact us to set up a consultation. The consultation is free and without obligation.
Thanks for reading!
80/20 Financial Services is an Independent Registered Investment Advisory Firm. We help electric cooperative employees retire.