Distribution Planning

When it comes to receiving the fruits of your labor (the money accumulated in your employer-sponsored retirement plan), you are faced with two broad options. You can elect to take the payout as a lump sum or as an annuity.

Planning the Best Distribution Option for You

The Annuity Option

If your retirement plan is inflexible, you may be forced to take the annuity option. Many company pension plans pay out in the form of an annuity. An annuity is a fixed monthly payment for the duration of your life.

The advantages of receiving an annuity include avoiding the temptation to squander or the pressure to invest a large sum of money which must last you the rest of your life. Also, there is no initial tax on the entire value of your retirement fund - each monthly payment is regarded as ordinary income and taxed accordingly.

If you are married, you may have the option to elect a joint and survivor annuity. With this option, you receive a lower monthly retirement payment, but in the event of your death, your spouse will continue to receive a portion of your retirement income. If you do not elect an annuity with a survivor option, your monthly payments end with your death.

The main disadvantage of the annuity option lies in the potential reduction of spending power over time. If we have annual inflation of 4 percent, the purchasing power of the fixed monthly payment would be halved in 18 years.

Since the life expectancy of the average 65-year-old is now an additional 20 years, you can see the potential difficulties of relying primarily on an annuity in your retirement years.

Lump Sum Distribution

If you decide to take the money as a lump sum, you receive the value of your account in one single payment and invest it as you see fit. You retain control of the principal and can use it whenever necessary for your children, grandchildren, vacations, or anything you want. You retain the autonomy to make your own investment decisions.

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There are certain tax options available that may reduce or defer your tax bill should you decide on a lump sum. However, unless there are exceptional circumstances, there is a 10 percent penalty imposed by the IRS on lump sum distributions taken before age 59 ½ that are not rolled over into an individual retirement account. This rollover must occur within 60 days of distribution.

In addition, lump sum distributions are subject to 20 percent withholding toward income taxes. This withholding can be avoided only by arranging for a direct trustee-to-trustee transfer of funds from your employer-sponsored plan into a traditional IRA or another qualified plan or kept in the former employer’s plan, if allowed.

Making an Informed Distribution Planning Decision

Before you take any action, it would be prudent to consult with a tax professional regarding your particular situation. Choose carefully, because your decision and the consequences will remain with you for life.