Pension plan distribution from a previous job or retirement can be a difficult thing to understand. How does it affect retirement? Can you roll over to an IRA? What about a lump-sum distribution? What you do with the money will have a direct impact on your tax bill. And while generally your two choices are to roll over the pension or have it paid directly to you, there are additional things to know:

In a direct rollover:

  • Your payment will be made directly to your IRA, or to your new employer’s plan.
  • Your payment will not have any tax withheld, nor will any tax be due.
  • Your payment will be taxed later when you begin to take distributions, presumably at retirement. If your distribution is paid to you:
    • Your payment will require a 20% tax withholding by the plan administrator. When you file your taxes, the 20% withholding is simply a credit against the full taxes that you will owe on the distribution. Since you didn’t pay taxes on the receipt of this money initially, you must pay them now if the distribution is paid directly to you.
    • You will still be able to roll over the distribution; however, you must do so within 60 days. Since 20% of the distribution was withheld (and sent to the IRS by your employer), you will only have 80% of the distribution available for the rollover. To roll over the entire distribution you’ll have to use another source of funds (such as your savings).
    • If you are under age 59 1/2, you may be subject to a 10% early withdrawal penalty (in addition to the income tax payable on the distribution). For example, if you receive a $100,000 distribution and are in the 28% tax bracket, you will be left with only $62,000 after paying taxes and penalties.

Rolling your distribution directly into a new or existing IRA is often the best and easiest solution to the problem. The human resources department at your firm will provide the necessary paperwork to complete the rollover into your IRA, and we will help you complete them. The distribution check should be made payable to the custodian of your IRA “FBO” (for the benefit of) your name.

Failure to take advantage of the distribution rollover is a surprisingly common mistake. Many individuals either neglect it as an option, or decide that they would like to get their hands on the money before it has had a chance to grow.

Often employees feel their distribution is too small to have an impact on their savings, or they are simply tempted to spend it. Taxes and penalties add up, and in this case, a penny saved may amount to many dollars earned by the time retirement rolls around. Give us a call at 888-529-2776 or contact us by email to discuss your specific situation.