Today, the retiree with only a single-employer pension is rare. With career changes and the availability of different types of tax-favored retirement plans, most successful individuals build an assortment of assets for retirement income. Each asset type likely has different payout options, distribution rules and tax implications. Crafting a strategy to best generate retirement income with the least tax impact is often complicated. When you retire, you need to carefully manage how you will draw on your assets. Any decisions should be based on thorough examination of all your choices with an investment professional.
The Tax Status of Your Assets
The law places restrictions on your freedom to withdraw from your assets. Access to tax-deferred1 assets, such as rollover and ordinary IRA money, annuities and deferred compensation from an employer, is subject to distribution requirements and possible tax penalties. Capital gains tax1 consequences may limit how you can make use of your personal investments and other assets. Because you will not get a second chance on many of your retirement asset decisions, it is smart to get a professional financial advisor to help you.
Look at the Big Picture
Begin by listing everything you have to work with—each of your assets and how much income each is likely to produce. When you withdraw income, you may be better off using some assets completely and holding other investments for later use. You should also make a list of the dates when you must start taking your distributions and any tax implications.
Use Taxable Assets First
If you decide to withdraw from ordinary investments and savings before tax-deferred assets, you can keep tax-deferred assets growing longer without the effect of annual taxes1. However, this strategy may be difficult to follow because the minimum distribution rules for tax-deferred assets prevent long delays in using tax-sheltered assets1. Generally, you must start taking minimum amount distributions by April 1 of the year after you turn age 70½ (or after retirement, if later).
Consider Annuity, Installment or Lump-sum Distributions
As for your tax-deferred plans such as a company pension, 401(k) or profit sharing, you can typically choose among annuity, installment and lump sum payments. With annuity payments, your options are income that will last for your life, or for both your and your spouse’s lives. With installment payments, you receive amounts over a number of years based on your life expectancy. With a lump sum payment, you receive a distribution of your entire retirement plan benefit right away. Your payout decision should follow a careful analysis by your financial advisor of your individual financial situation and needs.
Lump sum payments can lead to large income-tax liability. If you do not need the lump sum distribution you may be able to rollover your distribution directly into a tax-deferred IRA. If you do receive a lump sum from a non-qualified pension plan, you cannot roll it over into an IRA.
Usually, you must start receiving payments when you retire. Paying minimum taxes on multiple retirement assets will likely require you to use both your personal investments and some distributions of tax-deferred money. Step back and carefully consider all your alternatives and the associated taxes before you act, and do so with the help of an expert financial advisor.
Alternatives for Distribution of Tax-deferred Assets
|Usual Retirement Distribution Options||Special Taxes and Requirements|
|401(k) and Profit-Sharing Plan||