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August 5th, 2020 by

An ongoing study of IRA accounts has consistently found that women, on average, have lower retirement savings balances than men (see chart). Though there may be multiple reasons for this disparity, the most fundamental are the wage gap between men and women and the fact that women are more likely than men to take time off to care for children and other family members.1

The wage gap is narrowing for younger women, and more men are stay-at-home dads. But the imbalance remains.2 Obviously, earning less makes it more difficult to save for retirement. And a mother — or father — who stays at home to take care of the children may not be contributing to a retirement account at all. The same situation could arise later in life if one spouse works while the other takes time off or retires.

Additional Savings Opportunity

A spousal IRA — funded for a spouse who earns little or no income — offers an opportunity to help keep the retirement savings of both spouses on track. It also offers a larger potential tax deduction than a single IRA. A spousal IRA is not necessarily a separate account — it could be the same IRA that the spouse contributed to while working. Rather, the term refers to IRS rules that allow a married couple to fund separate IRA accounts for each spouse based on the couple’s joint income.

For tax years 2019 and 2020, an individual with earned income from wages or self-employment can contribute up to $6,000 annually to his or her own IRA and up to $6,000 more to a spouse’s IRA — regardless of whether the spouse works or not — as long as the couple’s combined earned income exceeds both contributions and they file a joint tax return. An additional $1,000 catch-up contribution can be made for each spouse who is 50 or older. Contributions for 2019 can be made up to the April 15, 2020, tax filing deadline.

All other IRA eligibility rules must be met. If a spousal contribution to a traditional IRA for 2019 is made for a nonworking spouse, she or he must be under age 70½; the age of the working spouse does not matter for purposes of the spousal IRA. For contributions made in 2020 and later years, the age 70½ restriction has been eliminated by the SECURE Act.

Traditional IRA Deductibility

If neither spouse actively participates in an employer-sponsored retirement plan such as a 401(k), contributions to a traditional IRA are fully tax deductible. However, if one or both spouses are active participants, federal income limits may affect the deductibility of contributions.

For 2019, the ability to deduct contributions to the IRA of an active participant is phased out at a joint modified adjusted gross income (MAGI) between $103,000 and $123,000, but contributions to the IRA of a nonparticipating spouse are phased out at a MAGI between $193,000 and $203,000. For 2020, phaseout ranges increase to $104,000–$124,000 and $196,000–$206,000, respectively.

Thus, some participants in workplace plans who earn too much to deduct an IRA contribution for themselves may be able to make a deductible IRA contribution for a nonparticipating spouse.

Withdrawals from traditional IRAs are taxed as ordinary income and may be subject to a 10% federal income tax penalty if withdrawn prior to age 59½, with certain exceptions as outlined by the IRS.

Sources:
1–2) Pew Research Center, 2019

July 30th, 2020 by

Businesses are responsible for paying payroll taxes for Social Security, Medicare, and unemployment for their employees, but not for independent contractors. And when using contract workers, employers avoid related expenses such as workers’ compensation insurance and other benefits. Instead, contractors pay self-employment taxes and cover their own work-related expenses.

For this reason, hiring independent contractors often makes sense for small businesses running on thin margins. However, it’s important to be aware that a complex web of tax and employment laws determines how workers must be classified. And misclassifying workers can be a costly proposition, even if it’s unintentional.

Multiple Tests Apply

Contractors are hired to deliver a certain result; how and when they get the work done is generally up to them. Employees are subject to much more employer control, but they are also eligible for worker protections such as wage and hour laws.

The IRS uses a three-part test based on whether the worker has behavioral and financial control, and the type of relationship with the employer (including the permanence). Under the federal Fair Labor Standards Act (FLSA), worker status is determined by an “economic reality” test that is similar, but not identical. Complicating matters, some states have rules that are stricter than the federal guidelines.

If your business is audited and the IRS or a state agency decides that one or more independent contractors were truly employees under the law, you might have to pay back taxes with interest, fines, and penalties. You also run the risk of being sued by misclassified workers.

Employee or Independent Contractor?

When hiring an independent contractor, there should always be a written agreement that specifies the project scope, payment, and other terms. Unfortunately, having a signed contract that says a worker is a contractor may not be enough, especially if any one of the following distinctions suggests otherwise.

1. Employees work according to a schedule defined by the business. Contractors set their own hours.

2. Employees receive regular paychecks through the payroll process. Contractors submit invoices and are treated as vendors under accounts payable.

3. Businesses provide equipment, supplies, and training for their employees. Contractors rely on their own knowledge and use their own tools.

4. Employees perform core business functions. Contractors typically provide supplemental services.

5. The work relationship between employers and employees is normally considered continuous or permanent. Contractors work on a temporary basis and typically have multiple clients.

Keep in mind that any contractor who works primarily for your business for a long period of time looks a lot like an employee. You shouldn’t hesitate to consult a qualified legal professional if you have questions about worker classification.

July 22nd, 2020 by

Each year, the Employee Benefit Research Institute (EBRI) surveys workers and retirees to assess how confident they are in their ability to live comfortably throughout retirement. In 2019, only 67% of workers reported feeling “very” or “somewhat” confident, compared with 82% of retirees.1

A closer look at the survey results reveals important lessons to be learned from retirees, whether your own retirement is coming soon or a distant goal.

Lesson 1: Don’t count on working longer. 

Almost three out of four workers expect work-related earnings to be at least a minor source of income in retirement, but just one in four retirees has worked for pay.2

Moreover, there is typically a big gap between expected and actual retirement ages. In 2019, workers expected to retire at a median age of 65, whereas retirees actually retired at a median age of 62. More than four in 10 retirees retired earlier than planned, often due to health issues or changes in their work situations.3 Your target retirement age is one area where you may want to hope for the best but prepare for the worst.

Lesson 2: Your income will largely depend on your savings efforts. 

Even though 64% of retirees receive income from a defined benefit plan (traditional pension), an even larger percentage rely on savings and investments, and more than half rely on income from IRAs and/or workplace retirement plans. Current workers are much less likely to have a pension, and more than half expect employer plans to play a “major” role in their retirement funding.4

If you have access to an employer plan, focus on saving as much as possible — and don’t despair if you are close to retirement and far behind your savings goals. You might be surprised by how much progress you could make in a few years. In 2020, you can contribute $19,500 to a 401(k) or 403(b) plan and an additional $6,500 catch-up contribution if you are age 50 or older.

Lesson 3: Health care may cost more than you think. 

More than one out of three retirees said their health-care or dental expenses were higher than they anticipated.5 Be sure to include medical expenses in your retirement savings strategy. According to another annual EBRI report, a 65-year-old couple who retired in 2019 might need about $300,000 to pay health-care expenses in retirement.6

Sources:
1–6) Employee Benefit Research Institute, 2019

July 15th, 2020 by

The Setting Every Community Up for Retirement Enhancement (SECURE) Act was enacted in December 2019 as part of a larger federal spending package. This long-awaited legislation expands savings opportunities for workers and includes new requirements and incentives for employers that provide retirement benefits. At the same time, it restricts a popular estate planning strategy for individuals with significant assets in IRAs and employer-sponsored retirement plans.

Here are some of the changes that may affect your retirement, tax, and estate planning strategies. All of these provisions were effective January 1, 2020, unless otherwise noted.

Benefits for Retirement Savers

Later RMDs. Individuals born on or after July 1, 1949, can wait until age 72 to take required minimum distributions (RMDs) from traditional IRAs and employer-sponsored retirement plans instead of starting them at age 70½ as required under previous law. This is a boon for individuals who don’t need the withdrawals for living expenses because it postpones payment of income taxes and gives the account a longer time to pursue tax-deferred growth. As under previous law, participants may be able to delay taking withdrawals from their current employer’s plan as long as they are still working.

No traditional IRA age limit. There is no longer a prohibition on contributing to a traditional IRA after age 70½ — taxpayers can make contributions at any age as long as they have earned income. This helps older workers who want to save while reducing their taxable income. But keep in mind that contributions to a traditional IRA only defer taxes. Withdrawals, including any earnings, are taxed as ordinary income, and a larger account balance will increase the RMDs that must start at age 72.

Tax breaks for special situations. For the 2019 and 2020 tax years, taxpayers may deduct unreimbursed medical expenses that exceed 7.5% of their adjusted gross income. In addition, withdrawals may be taken from tax-deferred accounts to cover medical expenses that exceed this threshold without owing the 10% penalty that normally applies before age 59½. (The threshold returns to 10% in 2021.) Penalty-free early withdrawals of up to $5,000 are also allowed to pay for expenses related to the birth or adoption of a child. Regular income taxes apply in both situations.

Tweaks to promote saving. To help workers track their retirement savings progress, employers must provide participants in defined contribution plans with annual statements that illustrate the value of their current retirement plan assets, expressed as monthly income received over a lifetime. Some plans with auto-enrollment may now automatically increase participant contributions until they reach 15% of salary, although employees can opt-out. (The previous ceiling was 10%.)

More part-timers gain access to retirement plans. For plan years beginning on or after January 1, 2021, part-time workers age 21 and older who log at least 500 hours annually for three consecutive years generally must be allowed to contribute to qualified retirement plans. (The previous requirement was 1,000 hours and one year of service.) However, employers will not be required to make matching or nonelective contributions on their behalf.

Benefits for Small Businesses

In 2019, only about half of people who worked for small businesses with fewer than 50 employees had access to retirement benefits.1 The SECURE Act includes provisions intended to make it easier and more affordable for small businesses to provide qualified retirement plans.

The tax credit that small businesses can take for starting a new retirement plan has increased. The new rule allows a credit equal to the greater of (1) $500 or (2) $250 times the number of non–highly compensated eligible employees or $5,000, whichever is less. The previous credit amount allowed was 50% of startup costs up to $1,000 ($500 maximum credit). There is also a new tax credit of up to $500 for employers that launch a SIMPLE IRA or 401(k) plan with automatic enrollment. Both credits are available for three years.

Effective January 1, 2021, employers will be permitted to join multiple employer plans (MEPs) regardless of industry, geographic location, or affiliation. “Open MEPs,” as they have become known, enable small employers to band together to provide a retirement plan with access to lower prices and other benefits typically reserved for large organizations. (Previously, groups of small businesses had to be related somehow in order to join an MEP.) The legislation also eliminates the “one bad apple” rule, so the failure of one employer in an MEP to meet plan requirements will no longer cause others to be disqualified.

Goodbye Stretch IRA

Under previous law, nonspouse beneficiaries who inherited assets in employer plans and IRAs could “stretch” RMDs — and the tax obligations associated with them — over their lifetimes. The new law generally requires a beneficiary who is more than 10 years younger than the original account owner to liquidate the inherited account within 10 years. Exceptions include a spouse, a disabled or chronically ill individual, and a minor child. The 10-year “clock” will begin when a child reaches the age of majority (18 in most states).

This shorter distribution period could result in bigger tax bills for children and grandchildren who inherit accounts. The 10-year liquidation rule also applies to IRA trust beneficiaries, which may conflict with the reasons a trust was originally created.

In addition to revisiting beneficiary designations, you might consider how IRA dollars fit into your overall estate plan. For example, it might make sense to convert traditional IRA funds to a Roth IRA, which can be inherited tax-free (if the five-year holding period has been met). Roth IRA conversions are taxable events, but if converted amounts are spread over the next several tax years, you may benefit from lower income tax rates, which are set to expire in 2026.

If you have questions about how the SECURE Act may impact your finances, this may be a good time to consult your financial, tax, and/or legal professionals.

Sources:
1) U.S. Bureau of Labor Statistics, 2019

July 8th, 2020 by

You may already have insurance to help support your family financially if you should pass away. But could your small business benefit from additional life insurance that would protect your employees, business partners, and their families?

Here are three life insurance strategies that could play a role in your business.

Group Plans

Small businesses have a hard time competing for qualified workers, many of whom may expect group life insurance as part of a standard benefits package. One cost-effective way to recruit and retain top talent is to provide a group term policy that provides a death benefit for the employees’ beneficiaries.

With group policies, the premiums may be employer-paid, employee-paid (voluntary), or a combination of the two. If the company pays some or all of the premiums, it may be possible to deduct the policy costs as a business expense.

Bonus Plans

As an incentive for critical employees, consider funding an executive bonus plan with cash-value life insurance. The business pays the life insurance premiums with bonuses that are tax deductible to the employer but taxable to employees. The company determines the amount of each bonus and when to pay it. A bonus plan may also be designed with vesting requirements that make the life insurance policy more valuable for an employee who remains with the company.

The employee owns the policy and bears the responsibility for keeping it in force. He or she can borrow against, and sometimes withdraw from, the cash value for any purpose; and if the policy is in force at the time of death, the employee’s named beneficiaries will receive the death benefit, minus any outstanding loans. (Loans will reduce the policy’s cash value and death benefit, could increase the chance that the policy will lapse, and might result in a tax liability if the policy terminates before the death of the insured.)

Succession Plans

Business partners often hold life insurance to fund buy-sell agreements. The death benefit can be used to purchase the business interests of the deceased partner from his or her heirs.

June 18th, 2020 by

After losing ground in 2018, U.S. stocks had a banner year in 2019, with the S&P 500 gaining almost 29% — the highest annual increase since 2013.1 It’s too early to know how 2020 will turn out, but you can count on market swings to challenge your patience as an investor.

The trend was steadily upward last year, but there were downturns along the way, including a single-day drop of almost 3% on August 14. That plunge began with bad economic news from Germany and China that triggered a flight to the relative safety of U.S. Treasury securities, driving the yield on the 10-year Treasury note below the 2-year note for the first time since 2007. A yield curve inversion has been a reliable predictor of past recessions and spooked the stock market.2 By the following day, however, the market was back on the rise.3

It’s possible that a yield curve inversion may no longer be a precursor to a recession. Still, larger concerns about the economy are ongoing, and this incident illustrates the pitfalls of overreacting to economic news. If you were also spooked on August 14, 2019, and sold some or all of your stock positions, you might have missed out on more than 13% equity market growth over the rest of the year.4

Tune Out the Noise

The media generates news 24 hours a day, seven days a week, and presents it through television, radio, print, and the Internet. You can check the market and access the news at work, in your car, and anywhere you carry a mobile device.

This barrage of information might make you feel that you should buy or sell investments in response to the latest news, whether it’s a market drop or an unexpected geopolitical event. This is a natural response, but it’s not wise to react emotionally to market swings or to news that you think might affect the market.

Stay the Course

Consider this advice from John Bogle, famed investor and mutual fund industry pioneer: “Stay the course. Regardless of what happens to the markets, stick to your investment program. Changing your strategy at the wrong time can be the single most devastating mistake you can make as an investor.”5

This doesn’t mean you should never buy or sell investments. However, the investments you buy and sell should be based on a sound strategy appropriate for your risk tolerance, financial goals, and time frame. And a sound investment strategy should carry you through market ups and downs.

It can be tough to keep cool when you see the market dropping or to control your exuberance when you see it shooting upward. But overreacting to market movements or trying to “time the market” by guessing at future direction may create an additional risk that could negatively affect your long-term portfolio performance.

Sources:
1) S&P Dow Jones Indices, 2020
2) The Wall Street Journal, August 14, 2019
3–4) Yahoo! Finance (S&P 500 index for the period 8/14/2019 to 12/31/2019)
5) MarketWatch, June 6, 2017

June 9th, 2020 by

On April 20, 2020, the price of a futures contract for West Texas Intermediate crude — the benchmark for U.S. oil prices — fell below zero for the first time in history, dropping more than 306% in trading on the New York Mercantile Exchange and ending the day at –$37.63 per barrel.1 Essentially, this meant that investors who would soon be obligated to take possession of a barrel of oil were willing to pay someone else to take it instead.

This unprecedented price collapse was for contracts scheduled to expire the following day and require delivery in May. June futures dropped 18% to about $20 a barrel, and the May contract clawed its way back to about $10 on April 21.2–3 But the dramatic plunge below zero highlighted a fundamental problem for the oil industry in the face of evaporating demand due to COVID-19. There is too much oil, and the industry is running out of places to put it.

Supply Without Demand

The International Energy Agency estimates that global demand for oil dropped by 29% in April 2020 compared with 12 months earlier and will drop by an average of 23% for the second quarter — equivalent to losing all of the oil consumption in the United States and Canada.4–5 The historic agreement by Russia, Saudi Arabia, and their allies (OPEC+) to reduce production beginning May 1 — equivalent to about 10% of global production — will help, but won’t be soon enough or large enough to stop the continuing expansion of supply, and storage facilities are filling up fast around the globe.6

The pressure is especially acute on West Texas Intermediate (WTI) crude and other U.S. oil stored for delivery in tanks at Cushing, Oklahoma. Under normal circumstances, oil passes through Cushing to refineries, but with diminished demand, the Cushing tanks are expected to be full sometime in May. Land-locked oil like WTI has nowhere else to go, which is one reason why traders were willing to pay to avoid taking delivery.7

A large exchange-traded fund (ETF) holding crude oil commodity futures contracts also played a major role in the rush below zero. ETFs hold futures strictly as paper investments with no intention or capability of taking delivery of oil — there are no storage tanks on Wall Street; they typically roll each month’s futures contract to the following month. But with no one willing to buy the May contract and accept actual delivery of oil, the ETF was forced to pay to get rid of the contracts. With storage problems likely to continue, June futures may face the same extreme price pressure as May.8

Brent Crude and Floating Storage

Whereas WTI contracts require accepting delivery of oil, contracts for Brent crude — the global benchmark — are settled in cash and unlikely to go negative. However, the physical price of Brent, which is pumped out of the North Sea, is already low and may go lower as storage tanks on the shore fill up, waiting for the oil to be loaded onto tankers. Like WTI, Brent is a high-quality oil, and other grades are typically sold at a discount to the benchmark. If Brent drops to $10, for example, oil from Saudi Arabia or Iraq could be priced below $0.9

The oil glut has created a record imbalance between near-term and long-term oil contracts, as traders anticipate increased consumption in the future. The disparity is great enough that some trading companies are buying cheap oil now and storing it on huge tankers that can carry 2 million barrels of oil.10 It’s estimated that a third of the world’s tanker fleet may be used for storage instead of transportation if the crisis continues.11

Not Worth Pumping

Oil prices are often volatile, but the dramatic drop in 2020 has been extraordinary, driven by the global pandemic shutdown and a price war between Russia and Saudi Arabia. On April 28, after the subzero dive had come and gone, the spot price for WTI — the price actually paid on delivery in Cushing — was $12.40 per barrel, down 80% for the year. The spot price for Brent was $15.60 per barrel, down 77%.12

At these price levels, it is no longer profitable for many producers to pump oil, especially for the more expensive shale-oil production methods used in the United States. In the four-week period ending April 17, U.S. oil production dropped by 900,000 barrels per day, about 7% of production and the largest one-month drop since the Great Recession. Some analysts expect an additional drop of 2 million barrels per day by year-end.13

Layoffs and rig closures have begun and are expected to expand quickly. Although large companies are likely to weather the storm, some smaller producers may be forced into bankruptcy. The U.S. Department of Energy has opened 30 million barrels of storage in the Strategic Petroleum Reserve for lease to private companies — equivalent to about 2.5 days of U.S. production — and plans to accept another 47 million barrels to fill the reserve to capacity; as of late April, no funding to purchase oil was available. Other forms of government support are being considered.14–16

Signs of a recovery in demand for oil in China have sparked some optimism, but the tension between supply and demand will continue to evolve, and extreme price volatility can be expected until the market finds balance through production cuts and/or rising demand.17

For now, keep in mind that oil prices are only one of many factors influencing the markets and the global economy. It’s important to maintain a long-term perspective and continue to focus on your own investment goals.

Sources:
1–3) MarketWatch, April 20 & 24, 2020
4) International Energy Agency, April 2020
5, 12, 16) U.S. Energy Information Administration, April 2020
6–7) The Wall Street Journal, April 22, 2020
8–9) Bloomberg, April 20 & 22, 2020
10) The Wall Street Journal, April 20, 2020
11) OilPrice.com, April 22, 2020
13) CNBC, April 22, 2020
14) CNN, April 21, 2020
15) U.S. Department of Energy, April 2, 2020
17) The Wall Street Journal, April 23, 2020

June 3rd, 2020 by

An annuity is an insurance contract that offers an income stream in return for one or more premium payments. Income payments continue for the duration of the contract, which may be for life or a specific number of years.

A fixed annuity offers a set rate of return for the life of the contract. A variable annuity is riskier but offers the potential for growth because a portion of the premium is invested in the financial markets; the annuity’s future value and income payments are largely determined by the performance of the investment subaccounts selected by the account owner.

Guaranteed living benefits are optional riders that can be attached to annuities for an additional cost. Here’s how living benefits might help you address two important retirement risks.

1. Outliving Your Savings

You can receive a lifetime income stream from an annuity in one of two ways: annuitization or withdrawals. When a contract is annuitized, the cash value is converted into a series of periodic income payments based primarily on current interest rates (or market-based returns) and your life expectancy. Control of the account transfers to the insurance company, so you no longer have access to the investment principal.

guaranteed lifetime withdrawal benefit (GLWB) is an optional lifetime income rider that can be attached to a variable annuity. It guarantees that you can withdraw a minimum amount of income from a variable annuity for life without having to annuitize, even if the original account value is depleted. If the markets perform well, the income amount could increase, but it typically cannot decrease unless you take a withdrawal that exceeds the guaranteed withdrawal amount. The remaining account value may be available for other purposes and inherited by your designated beneficiaries after death.

2. Paying for Long-Term Care

Adding a long-term care (LTC) rider to a fixed or variable annuity might help prevent your savings from being depleted by escalating costs. Benefits are typically triggered if you are diagnosed with dementia or are unable to perform two or more activities of daily living such as eating, bathing, and dressing. If care is needed, the payout is increased for a specified period of time or until the account value reaches zero. And if you never need care, you can continue to earn a return on your money. Medical underwriting requirements tend to be more lenient with an LTC rider than with a standalone policy, and you don’t have to worry about future rate increases or the issuer canceling the policy.

Any annuity guarantees are contingent on the financial strength and claims-paying ability of the issuing insurance company. Annuities are not guaranteed by the FDIC or any other government agency. They are not deposits of, nor are they guaranteed or endorsed by, any bank or savings association. Annuities typically have contract limitations, fees, and charges, which can include mortality and expense charges, account fees, investment management fees, administrative fees, charges for optional benefits, holding periods, termination provisions, and terms for keeping the contract in force.

A variable annuity is a long-term investment product designed for retirement purposes. Variable annuities that come with living benefits tend to have more limited investment options. The investment return and principal value of the investment options are not guaranteed and may fluctuate with changes in market conditions. When the annuity is surrendered or annuitized, the principal may be worth more or less than the original amount invested.

May 27th, 2020 by

Widespread smartphone use, loosening regulations, and employers seeking health cost savings are three trends that were driving the rapid expansion of telemedicine. And that was before social distancing guidelines to help control the spread of COVID-19 made the availability of remote medical care more vital than anyone anticipated. 

Telemedicine offers a way for patients to interact with doctors or nurses through a website or mobile app using secure audio or video connection. Patients have immediate access to advice and treatment at any time of the day or night while avoiding unnecessary and costly emergency room visits. And health providers have the ability to bill for consultations and other services provided from a distance.

Telemedicine can be used to treat minor health problems such as allergies and rashes, or for an urgent condition such as a high fever. It also makes it easier to access therapy for mental health issues such as depression and anxiety. In other cases, doctors can monitor the vital signs of health patients with chronic conditions remotely, or follow up with patients after a hospital discharge. Telemedicine can also fill gaps in the availability of specialty care, especially in rural areas.

In 2019, nearly nine out of 10 large employers (with 500 or more employees) offered telemedicine programs in their benefit packages, but many workers had not tried them out. Only 9% of eligible employees utilized telemedicine services in 2018 (the most recent year for which data is available), even though virtual consultations often have lower copays and are generally less expensive than in-person office visits, especially for those with high deductibles.1

If your health plan includes telemedicine services, you might take a closer look at the details, download the app, and/or register for an online account. This way, you’ll be ready to log in quickly the next time your family faces a medical problem.

1) Mercer National Survey of Employer-Sponsored Health Plans 2019

January 16th, 2020 by

If you receive a distribution from a qualified retirement plan such as a 401(k), you need to consider whether to pay taxes now or to roll over the account to another tax-deferred plan. A correctly implemented rollover avoids current taxes and allows the funds to continue accumulating tax-deferred.

MOST TAX-EFFICIENT WAY TO TAKE A DISTRIBUTION FROM A RETIREMENT PLAN

PAYING CURRENT TAXES WITH A LUMP-SUM DISTRIBUTION

If you decide to take a lump-sum distribution, income taxes are due on the total amount of the distribution (except for any after-tax contributions you’ve made) and are due in the year in which you cash out. Employers are required to withhold 20% automatically from the check and apply it toward federal income taxes, so you will receive only 80% of your total vested value in the plan. (Special rules apply to Roth accounts.)

The advantage of a lump-sum distribution is that you can spend or invest the balance as you wish. The problem with this approach is parting with all those tax dollars. Income taxes on the total distribution are taxed at your marginal income tax rate. If the distribution is large, it could easily move you into a higher tax bracket. Distributions taken prior to age 59½ are subject to a 10% federal income tax penalty. (Special rules may apply if you were born before 1936.)

DEFERRING TAXES WITH A ROLLOVER

If you don’t qualify for the above options or don’t want to pay current taxes on your lump-sum distribution, you can roll the money into a traditional IRA.

If you choose a rollover from a tax-deferred plan to a Roth IRA, you must pay income taxes on the total amount converted in that tax year. However, future withdrawals of earnings from a Roth IRA are free of federal income tax after age 59½ as long as the five-tax year holding requirement has been met. Even if you are not 59½, your distribution may be tax-free if you are disabled or a first-time home purchaser ($10,000 lifetime maximum), as long as you satisfy the five-year holding period.

If you elect to use an IRA rollover, you can avoid potential tax and penalty problems by electing a direct trustee-to-trustee transfer; in other words, the money never passes through your hands. IRA rollovers must be completed within 60 days of the distribution to avoid current taxes and penalties.

An IRA rollover allows your retirement nest egg to continue compounding tax-deferred. Remember that you must generally begin taking annual required minimum distributions (RMDs) from tax-deferred retirement plans after you turn 70½ (the first distribution must be taken no later than April 1 of the year after the year in which you reach age 70½). Failure to take an RMD subjects the funds that should have been withdrawn to a 50% federal income tax penalty.

Of course, there is also the possibility that you may be able to keep the funds in your former employer’s plan or move it to your new employer’s plan if allowed by the plans. (Make sure you understand the pros and cons of rolling funds from an employer plan to an IRA before you take any action.)

Before you decide which method to take for distributions from a qualified retirement plan, it would be prudent to consult with a professional tax advisor.

Let me guide you through your retirement planning decisions. Contact me for a FREE retirement strategy consultation at my office in Upper Marlboro, MD. 

Contact me TEL: 1-833-313-7233.

Retirement Specialist Freeman Owen, Jr.