Early Retirement Plan

Early Retirement Plan Payout Means Tax Decisions

Retirement is just one of many events that can trigger a retirement plan distribution -- changing jobs, getting laid off, or losing a job due to a merger or acquisition are just a few other examples. Today, it is not unusual for a person who is years away from retirement to suddenly find him- or herself with a lump-sum retirement plan payout of $50,000, $100,000, or more.

If you receive an early distribution of your retirement plan funds, you have to make some important decisions about what to do with your money. Income-tax considerations may play a large role in this process.

The tax law provides three general alternatives for taxing a lump-sum retirement plan distribution.

Immediate And Full Taxation

The first requires you to include the entire taxable amount in your income in the year you receive it. That amount is taxed at your ordinary income-tax rate.

Forward Averaging

The second allows you to use five-year forward averaging to reduce your current tax on the lump sum. But forward averaging generally is only available to those age 59 1/2 or older and is available only once in a lifetime. (If you were 50 or older before January 1, 1986, special rules apply.) Due to the age requirement, most people receiving early plan distributions are not eligible for forward averaging. Note, too, that five-year averaging will not be available after 1999.

Note that where the distribution takes place before age 59 1/2, the distribution may also be subject to a 10% early withdrawal penalty in addition to income taxes. There are a number of exceptions to the penalty, however.

Rollover

The third alternative is to "roll over" the taxable portion of the lump-sum distribution to an Individual Retirement Account (or a new employer's eligible plan). You won't owe any tax or penalty on the amount distributed until it is withdrawn from the rollover IRA or plan. Earnings on the rolled-over distribution continue to be tax-deferred. But you must make the rollover within 60 days after your payout, or you forfeit your ability to do so. Therefore, you must decide fast what tax route you want to follow.

Be aware that distributions other than lump-sum distributions also may qualify for rollover treatment. An "eligible rollover distribution" is defined as any distribution from a tax-qualified plan other than:

• one of a series of annuity payments made at least once a year for life
• one of a series of substantially equal payments made at least annually over a specified period of ten years or longer; or
• a required minimum distribution made after age 70 1/2

All eligible rollover distributions are subject to a 20% withholding tax unless the distribution is directly transferred from the paying plan to the rollover IRA or plan. Thus, if you want to roll over your distribution, you should arrange with the paying plan for a direct transfer. If you receive the money, even if you intend to roll it over, withholding is mandatory. While the withheld amount may be refundable to you on filing your tax return, you could be left in a situation where you need to make up the withheld 20% from other funds in order to make a full rollover within the 60-day period.

Determining the most favorable tax treatment is just the first step. Often -- especially where a distribution has been rolled over to an IRA -- the investment of the fund is left in the hands of the recipient. Investment decisions should be carefully thought out. You may not need the money for retirement for 10, 20, or more years. How you invest the money and the annual investment return you earn can have a dramatic effect on the sum eventually available at retirement time. For this reason, professional investment advice is recommended.

ENB Associates Inc. is a wholly owned subsidiary of Evans National Bank. Securities are offered by O'Keefe Shaw & Co., Inc. Member NASD, and SIPC. Products purchased through O'Keefe Shaw may lose value, are not deposits with obligations of, or guaranteed by Evans National Bank or affiliates and are not insured by the FDIC.