This week, Gail explains the tax impact of payouts from company retirement plans and offers her advice on rolling your retirement account into an IRA.
Gail;
I am taking an early retirement where I work. A downside is that it is in the form of a single lump sum payout this year equal to 15 months' salary. This will push me into a new tax bracket.
What are some of the things I could plan to do this year to help keep down my adjusted gross income? Some of the suggestions I've already heard are maximizing my 401k plan pre-tax contribution before I leave, prepaying some mortgage interest, paying next year's property taxes.
Regards,
John
Dear John,
Frankly, there isn't a lot you can do to offset this extra income. As you point out, one strategy would be to maximize your contribution to your 401(k). This year you can contribute $11,000, with an additional $1,000 if you are over age 50.
If you get a new job with another company — even part-time — you might be able to also contribute to that company's plan, depending upon the type. For instance, if you got a part-time teaching job, you could maximize contributions your 403(b) plan ($11,000) on top of what you've put into your former employer's 401(k).
Will you start your own business? Setting up a retirement plan for yourself is another way to reduce your taxable income.
Pre-paying tax-deductible expenses such as your mortgage and property taxes will also help. Look for other items which fall into this category such as medical expenses (they have to exceed 7.5% of your adjusted gross income to be deductible), non-reimbursed business expenses (the cost of setting up your own consulting business, for instance). Starting this year, taxpayers whose incomes fall within certain limits can deduct up to $2,000 of a child's qualified college costs.
Don't forget capital losses. Take a look at your investments and consider selling those that are worth less than what you paid for them. Capital losses must first be used to offset capital gains, but you can apply up to $3,000 of excess losses against this year's income.
I strongly suggest you sit down with a tax professional who can review your options and the sooner you do this, the better. Too often, people wait until the end of the year to do this kind of tax planning. That can be too late. You're right in getting the jump on this while you still have time to maneuver.
However, I wouldn't panic about being "pushed into a higher tax bracket". The higher tax rate does not apply to ALL your income. Only the incremental dollars that fall in the higher bracket are taxed at that rate. And keep in mind, tax rates have been reduced again this year.
For instance, let's suppose you are married. This year, you can have as much as $112,850 in (adjusted) income and still be in the "27% bracket." If your early retirement buy-out raises your AGI to $122,850, you are technically now in the 30% tax bracket. But only the additional $10,000 will be taxed at that rate.
Here are this year's income tax rates and the income levels on which they apply:
Tax on first $12,000: 10%
Tax on $12,001-$46,700: 15%
Tax on $46,701-$112,850: 27%
Tax on $112,851-$171,950: 30%
Tax on $171,951-$307,050: 35%
Tax on $307,051 and above: 38.6%
Having more income is what I call a happy problem. I agree you should minimize the tax bite to the extent possible, but consider yourself fortunate to be getting this early retirement buy-out from your employer.
These days, a lot of other folks are much less fortunate.
Happy retirement!
Gail
Dear Gail,
I resigned from my company a couple of months ago and was 100% vested in the retirement plan.
The company representative told me that since the balance exceeds a certain amount, I cannot roll it into another retirement plan, such as an IRA. Is this true? I am very nervous as to whether this money will be available to me when I retire in thirty years after I read about how many Enron employees lost their pensions.
What are my options?
Thanks for your help,
Patrick
Dear Patrick,
April Caudill, a retirement plans specialist at the National Underwriter company, has never heard of this! She says there is no provision in the tax code which limits how much you can roll over from a qualified plan.
It's possible that a plan might limit how much you can withdraw as a lump sum, but this, too, according to Caudill, is the exception rather than the rule.
In fact, because IRA regulations have become much more flexible in the past year, the trend is just the opposite: more and more company plans are encouraging you to roll your account balance into an IRA.
Don't just take the word of someone in human resources. Contact your plan administrator and request a copy of the "summary plan description." They must provide this by law. It's an abbreviated form of the plan itself and lays out what you can and cannot do with your money as a participant in the plan. Your rights and choices should be clearly described. It should also explain what kinds of investments the company can use.
Keep in mind, the reason Enron employees suffered was a result of having so much of their 401(k) assets invested in Enron stock. In fact, at one point in early 2001 roughly 60% of all the assets in the plan was invested in company stock- an absurd and reckless amount. And a good portion of that was because Enron employees themselves were buying it for their own accounts, adding to the amount the company was contributing.
Hope this helps,
Gail
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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.
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