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Managing Your Retirement Rollover

By Douglas Charney

Change is commonplace in the volatile American economy. When a major life change requires you to rethink your retirement plans, you need to consider numerous factors, including portfolio distribution methods, tax options and rollover strategies. Will you make the right decision?

Whether you’re changing jobs, funding your child’s education, or retiring early, you have some decisions to make that may directly affect your retirement lifestyle. The complex choices may require the advice of a financial advisor, but you can start by thinking about what method of retirement management is best for your needs. Three main options exist, each with pros and cons, for managing your retirement:

1. Take Your Payment as an Annuity. If you decide to take your retirement savings as an annuity, you will receive a series of payments based on your life expectancy. Hopefully, you’ll outlive your expectancy, and in this case, you will continue to receive the payments. Consider the two types of annuities

a. Single-life annuity provides a monthly payment over your lifetime.

b. Joint and survivor annuities provide for your spouse and dependents after your death, although the payments in this option are typically 30% less than the single life annuity because they cover a longer period of time. For example, instead of receiving $1,000 a month for twenty years, you would receive $700 a month for thirty years.

Another strategy for annuities is pension maximization. In this case, you chose a single life annuity option and use the extra income to purchase a life insurance policy. When you die, the life insurance replaces the annuity payment for your survivors.

2. Take the Retirement Payment as a Lump Sum. This option has positive and negative aspects. If you take the lump sum directly, then you will have 20% of the distribution withheld for federal income tax. If you are under 59 ½ years old, you’ll be subject to an additional 10% early withdrawal penalty. However, death, disability, separation from service, and some medical expenses are a few exceptions to the early withdrawal penalty. If you are over 59 ½ years old, you can avoid the mandatory 20% withholding by rolling the funds over into an IRA and then taking the money out.

The positive aspect of taking the lump sum is freedom of investment. Instead of conforming to your employer’s retirement plan, you are free to invest the money however you like. You can work with the financial institution of your choice and develop a personalized plan that best fits your needs. As your needs change, you can reinvest the money as you see fit because you are not locked into anything.

Before deciding on an investment level for your lump sum, plan a strategy that suits your needs. First, assess you level of risk, as some investments are riskier than others. You wouldn’t want to get involved in an investment that could wipe out your savings if it fails. Next, determine your objectives and allocate your assets in a properly diversified portfolio designed to meet your needs. The five different levels of investment objectives I employ are: defensive, moderate income, balanced growth and income, growth and aggressive growth. Your objectives and needs will vary depending on your age, risk tolerance and investment time horizon. You will need to review your portfolio from time to time as your objectives change or your investments perform differently.

If you’ve taken the lump sum amount, you will need to consider some tax options. You may add the sum to your regular earned income for the year and pay your taxes accordingly, but this method results in the highest amount of taxes payable on your distribution. Usually, you save some money if you participate in a five- or ten- year averaging program. A five-year averaging program allows you to treat the distribution as if you’ve received payments over five years. Simply take the whole amount and divide it by five. You qualify for this method if you’ve participated in the employer’s retirement program for at least five years, received a qualifying distribution and received a total distribution. Ten-year averaging works just the same way as five-year, only you divide the amount by ten, calculate the taxes, then multiply the tax amount by ten. To qualify for this method, you must have been born before 1936, participated in the retirement program for at least five years, received a qualifying distribution and received a total distribution.

3. Roll the Money into an IRA. After leaving your job, the most effective method of managing your retirement fund is to roll it directly into an IRA, which allows you to take your lump sum without paying current taxes and still maintaining the tax-deferred growth. IRAs offer some flexibility as well. You control your retirement funds among many options, including CDs, stocks, bonds, mutual funds and annuities. To do this, arrange to have the money transferred from the trustee of the retirement plan to the custodian of the IRA. When done correctly you can avoid withholding and current income taxes.

If you decide to rollover your savings into an IRA and take some money out, you may be able to avoid the 10% early withdrawal penalty, making an IRA a good option for parents whose children may attend college or for those who may want to retire early. Substantially equal payments from your IRA are not subject to the 10% penalty if they are payable for five years or until you turn 59 ½, whichever is longer. For example, if you decide to take a withdrawal at age 50, you can do so penalty-free as long as you receive payments over a period of 9 ½ years. These payments would be based on your life expectancy at age 50. Similarly, if you tap your IRA at age 58, you may do so without penalty as long as you receive payments over a period of five years, even though you will turn 59 ½ before that time.

Decide Wisely

Don’t get caught in a retirement investment decision that doesn't produce the results you want. Your best management plan will depend on your personal needs and your desired retirement lifestyle. Annuities, lump sums, and IRA rollover options each have their positive and negative aspects. Your financial advisor can help you assess your goals and develop a plan that is right for you.

As Financial Advisors do not offer legal or tax advice, we recommend you consult with your chosen legal or tax advisor before making any investment decisions. Keep these retirement management options in mind as you face your life change and redevelop your strategy.

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