Even if you are several years away from retirement, it’s not too early to start gathering facts, weighing choices and mapping out your tax and investment strategy. Here are several suggestions that should help you organize your planning.

1. Be aware of the Social Security and Medicare benefits that you will receive. You can receive a reduced Social Security benefit any time after reaching age 62. The full benefit shown on your annual Social Security estimate statement will be yours when you reach “normal retirement age,” which is now rising gradually. The age applicable to you depends on your year of birth and is shown on your estimate statement. You need to apply for Social Security at your local Social Security office or on the Internet at www.ssa.gov a few months prior to your intended retirement date.
You can begin receiving Medicare benefits, covering a substantial part of your health care costs, at age 65. Information on coverage and the application process is available by telephone at 1-800-MEDICARE or on the Internet at www.medicare.gov.

2. Find out about company health benefits. Although Medicare is fairly comprehensive, there are gaps that you may need to fill. Some companies recognize this fact and offer employees supplemental health insurance plans or group rates.

3. Find out about retirement benefits. You’ll want to know whether you will be receiving regular, fixed payments or whether you have the option to take your benefits in a lump sum. If you choose a lump sum, you’ll have to make another decision: to keep the money and pay tax on it immediately or set up a Rollover IRA. There are limited tax breaks available for your payout. Thus, you may be taxed at your ordinary income tax rate. If you set up the Rollover IRA, you can continue to shelter income earned in the account until you are required to begin making withdrawals at age 701/2.

4. Develop an investment strategy. Conventional wisdom for retirees stresses the need to play it safe. Usually the approach recommended is to reduce risk and enhance income. But few investments are risk free. Rising living costs can make even fixed-income investments look, in hindsight, like a risky investment. Your investments should be geared to your own financial picture and your own tax outlook.

5. Determine who will oversee your investments. Your own background and tempera-ment will determine the best way to manage your investments. With leisure time, you may enjoy monitoring your portfolio. On the other hand, you may want to travel or pursue new interests, and you’ll want to put your portfolio in the hands of a professional investment manager. Perhaps you want to do it yourself but would like a “second opinion.” A trust officer can explain the many choices available.

6. Plan for the unexpected. Many people are concerned about more than the management of their portfolio after retirement. They have questions such as: What happens to my finances in the event of my disability or prolonged illness? How can I provide for continuing income and support for loved ones after my death? One possible answer is to consult a trust officer about a living trust—a comprehensive, long-term investment plan that can help resolve these concerns.

7. Look for ways to augment your retirement capital. Usually the last years before retirement are years of peak earning power. Contribute as much as you can to tax-deferred retirement plans, such as an IRA or a company 401(k) plan.

8. Stage a “dress rehearsal” for retirement. Estimate your monthly income and monthly expenses. If you believe that your expenses will be less, take that into account.

Then try living for a month, now, on what you plan to live on later.
Of course, financial planning won’t be the only planning you need to do. You may want to look for a new place to live, make extensive travel plans or take up the hobby that you’ve never had time for before. Whatever the anticipated pleasures of retirement are, you’ll enjoy them all the more when you know your financial future is secure.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

Taxes play an important role in your retirement planning. For instance, if you are a 401(k) or other retirement plan participant and will receive a lump sum distribution, taxes may affect your choice of what to do with the payout.

Several approaches
In broad outline, when the time comes to receive a payout from your company retirement plan: (1) You can take the lump sum, pay the tax owed (at ordinary income tax rates) and then invest what’s left. (If you are under age 59 1/2 when you take your funds, you may be hit with a 10% penalty, too.); or (2) you can roll over your distribution directly from the plan to an IRA. Your retirement assets then continue to grow tax deferred.
Do you own employer stock? It’s not unusual. According to a survey conducted by the Employee Benefit Research Institute, 41% of 401(k) participants held more than 20% of their assets in company stock. And that fact may dictate a different approach to how you manage your payout—one that combines elements of both of the strategies above. Why? You may be able to achieve significant tax savings by segregating your company stock from what you intend to roll over—often referred to as the “net unrealized appreciation” (NUA) approach.

Mapping out a Rollover IRA
For many people the decision to roll over at least part of a retirement payout will be the best one.
The first step in the rollover approach is to make advance arrangements for a direct rollover of the balance from your plan account to an IRA. Do not receive the funds from the plan yourself. If you do, your employer, by law, is required to withhold 20% of your distribution for income taxes.
It’s not fatal if you don’t arrange for a direct rollover, but matters do become a bit complicated. You still can execute the rollover, as long it’s done within 60 days. You also are allowed to contribute from other savings the amount that was withheld for taxes. (You will be entitled to a tax refund for the amount that has been withheld.) If you don’t add in the withheld amount, it’s considered a distribution and taxed as ordinary income.

Using an NUA approach
A combined Rollover IRA/NUA approach works like this: You arrange for a direct rollover of your lump sum, minus the employer-stock portion. Instead, the employer stock becomes part of your personal portfolio. The rollover portion of your payout escapes current tax, but it will be taxed at ordinary income tax rates when withdrawn.
To understand how the tax on your employer stock is calculated, it’s best to think of four taxable blocks that, together, make up what you will owe:

• Block one consists of what your company paid for all of the stock contributions made to your plan account (the stock’s average cost basis). This amount is taxed at ordinary income tax rates at the time of the stock’s distribution.

• Block two is the NUA—the difference between the average cost basis and the market value of the stock at the time of the distribution. NUA always is taxed at long-term capital gain rates determined at the time of distribution (currently, a maximum of 15%), not at ordinary income tax rates (up to 35%), but the tax doesn’t have to be paid until the stock’s eventual sale.

• Block three is the dividends earned on the company stock after the distribution. Under current rules the dividends may be eligible for special tax treatment—a 15% tax rate. (Had the stock been rolled over into an IRA, dividends earned would have come out of the IRA taxed at ordinary income tax rates.)

• Block four is the additional appreciation (if any) that occurs between the distribution and the sale of the stock. This block is taxed at either short-term or long-term capital gain rates, depending upon how long that the shares are held.

The other side of the coin
Along with the potential rewards of taking an NUA approach, there are some reasons to look before you leap. For instance, by making your company stock a part of your taxable portfolio, you lose the opportunity to diversify out of the stock without paying capital gains tax. In addition, assets not sheltered from a tax-deferred retirement account may have less protection from creditors. Finally, tax rates can change, or the price of the company shares may decrease, eliminating some of the anticipated tax benefits with the NUA approach.

Obtaining professional guidance is strongly recommended. In our roles as trustee or investment advisor, we have helped many a retiree shape and execute a tax strategy for a retirement plan payout, designed specifically to meet his or her goals and needs. We would be glad to discuss how we can assist you.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

A taxpayer, let’s call him Bob, left his job and received a lump sum payout of his pension accumulation. Let’s say that the payment was $100,000. To protect his retirement nest egg, Bob rolled the entire amount over to an IRA. Unfortunately, and unbeknownst to Bob, there had been a serious mistake by the pension plan administrator in calculating his lump sum, and Bob was paid more than he was due. Years later, when the mistake was discovered, Bob was required to repay $20,000 to the pension plan. He took the money for the repayment from his IRA rollover.

Tax consequences?
For Bob, there are three separate tax problems here, according to the IRS Chief Counsel Advice that analyzed the situation.
First, Bob was only eligible to roll $80,000 into the IRA the year that he received the lump sum distribution, even though he had no way of knowing that. The excess $20,000 should have been included in his taxable income that year. However, in the fact pattern the IRS stipulates that so much time has elapsed since the rollover that a collection of that tax is now barred by the statute of limitations.

Second, the extra $20,000 rolled into the IRA is subject to a 6% annual excise tax until it is “absorbed” or offset by later IRA contributions not made. Let’s say that in the year after the rollover, Bob was eligible to set aside $5,000 in an IRA, but he made no contribution that year. The “excess” in the rollover then is reduced from $20,000 to $15,000, and so on each year until it is covered. But if Bob made a contribution of, for example, $3,000 in the second year, only $2,000 of the excess would be absorbed, leaving $18,000 exposed to the continuing 6% annual penalty.
Finally, the $20,000 that Bob withdrew from his IRA to repay to the pension plan must be included in his taxable income in the year of the withdrawal. That would be consistent with the way Bob reported the rollover the year he received the lump sum, and he can’t change that now that the statue of limitations has expired. However, if the problem had come up earlier, before the statute of limitations had expired, Bob might have been able to mitigate the problem through a corrective procedure in the tax code.

Also, Bob will be able to take a tax deduction for the repayment, but that will be a miscellaneous deduction. These are only deductible to the extent that they exceed 2% of adjusted gross income.
What should someone in Bob’s situation do? Ideally, in the year of the lump sum distribution, an independent actuary should be consulted to confirm the accuracy of the calculations.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

The rules governing the tax treatment of withdrawals from a traditional IRA are three-pronged: Generally, you must pay tax on any withdrawals that you make prior to reaching age 59 1/2 and face an additional 10% tax for what is referred to by the IRS as an “early distribution.”
Between ages 59 1/2 and 70 1/2, the rule is that you pay ordinary income tax on the amount that you withdraw in the year that you withdraw it. That’s it, pure and simple.
Finally, once you reach age 70 1/2, you must begin to make annual withdrawals. A major penalty looms: If you fail to withdraw the required amount, you pay a whopping 50% penalty on the difference between what you should have withdrawn and what you actually did withdraw.

Exceptions to the 10% tax
If you need to need to tap a traditional IRA, although you never can avoid paying ordinary income tax on your withdrawals, there are instances when you can avoid paying the additional 10% tax. Here they are in a nutshell:

Death. As long as your IRA still is in your name at your death, generally, when the beneficiary of your IRA makes withdrawals, he or she will not have to pay the 10% additional tax. However, if an IRA is inherited from a spouse who elects to treat it as his or her own IRA, distributions prior to age 59 1/2 will be subject to the additional tax.

Disability. You will not have to pay the additional tax if you are disabled. You will be considered disabled, according to the IRS, if “you can furnish proof that you cannot do any substantial gainful activity because of your physical or mental condition.” A physician must determine that your condition can be expected to result in death or to be of “long, continued, and indefinite duration.”

Unreimbursed medical expenses. The additional tax also is avoided when you make withdrawals to pay for “qualified unreimbursed medical expenses” greater than 10% of your adjusted gross income. (These are expenses that will meet the standards for deductibility on your income tax return.) Two points to keep in mind: The expenses may be either yours, your spouse’s or your dependents,’ and you need not actually itemize your deductions on your tax return to qualify under this exception.

Health insurance premiums for the unemployed. No additional tax will be imposed for withdrawals to pay health insurance premiums for you, your spouse and your dependents as long as you have received unemployment compensation under a federal or state law for at least 12 consecutive weeks. The withdrawals must be received either during the year of the receipt of unemployment compensation or the following year and also must be received no later than 60 days after you have become reemployed. If you were self-employed before you stopped working, your IRA withdrawals won’t be subject to the 10% tax, as long as you would have qualified for unemployment, but for the fact that you were self-employed.

Home-buying expenses. A withdrawal of up to $10,000 to pay the expenses of purchasing, building or reconstructing a first-time home will not be penalized. The qualified expenses here are those paid in connection with a “principal” residence. The funds must be used within 120 days of receipt.

Higher-education expenses. A withdrawal from an IRA that is used to pay certain education expenses of a beneficiary (yourself, your spouse or children and grandchildren of you or your spouse) who are at least 18 years of age may not be subject to the 10% additional tax. Qualified higher education expenses include tuition, books, supplies and equipment. Room and board expenses also may qualify as long as the beneficiary is at least a “half-time” student.

The “periodic payments” rules
Another way to avoid the imposition of the 10% early distribution tax is to arrange to receive your withdrawals as a series of “substantially equal periodic payments” over your life expectancy or the joint life expectancy of you and your IRA beneficiary. The withdrawals must be taken annually and continue for at least five years or until you reach age 59 1/2, whichever is the longer period.

There are three IRS-approved methods for satisfying this exception. Once you have chosen to take your withdrawals under one of the three methods, the rules do not accommodate any switch from one of the approved methods to another before the end of the waiting period without the imposition of the additional 10% tax (except in the case of death or disability).

A note on Roth IRAs
Because contributions to a Roth IRA are made with previously taxed dollars, withdrawals may be completely tax free. That rule holds fast for withdrawals of your contributions. However, for tax-free withdrawals of the earnings from your Roth IRA investments (and to avoid the 10% additional tax), they must be “qualified distributions.” For a withdrawal to be a qualified distribution, you must have owned the Roth IRA for five years and be at least age 59 1/2.

If you have owned the IRA for five years, but have not reached age 59 1/2, you may avoid both the ordinary income tax and the additional tax when you meet one of the exceptions from the imposition of the 10% tax described in the traditional IRA discussion above.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.