Retirement, whether on-time or early, involves many tough choices, but in the era of ever-more-complicated pension and retirement savings plans, few decisions are tougher than figuring out how and when to take your money.
The options are legion. A worker today may well have the choice of an annuity for him/herself only, an annuity that covers both the worker and a surviving spouse, a lump-sum payment in cash, a rollover to an individual retirement account or simply leaving the money in the company plan.
What is available depends on the terms of the worker's pension or savings plan. Which of the available choices will work best depends on the worker's personal situation and goals.
And besides being hideously complicated -- with some choices requiring forecasts -- the decision is critically important.
"For a lot of people now, even higher-level people, the main asset is their plan. You don't want to make a mistake with that," said Karen Field of the Washington, D.C., office of KPMG Peat Marwick, a big accounting firm.
Avoiding an expensive error takes study and planning, and may require professional advice. Key moves, experts say, are finding out what your plan offers and what it allows, and then looking to see how the available options fit in with your situation.
Working couples need to examine both spouses' options to see how they can be meshed best.
"There is certainly a thought process" that can be used to impose some order on your situation, once you know what the choices are, Field said.
The first stop should be the benefits office of your employer. Find out the type of retirement plan or plans you have and what their terms are.
The first decision may be between an annuity and some form of lump-sum payout. Not all plans offer a choice, but many do. A life annuity will ensure a stream of income you cannot outlive, but generally will end at your death.
Take into account your health as well as your financial circumstances. Poor health or a family history of early death weigh in favor of a lump sum.
"Take an annuity if you are worried about running out of money," Field said. "Annuities are safe. If you are fairly certain something else is going to cover your retirement needs, you can take a lump sum," which you can use for investment, estate planning and the like.
If you take an annuity, you usually will have a choice between a self only or a joint and survivor arrangement. The self-only option usually provides larger payments but only for your lifetime. The survivor option pays less but ensures income for both you and your spouse or some other survivor.
If you opt for a lump sum, or have no choice but to take one, several more choices arise. You can roll it over into an IRA, thus postponing taxes, or you can leave the money in your employer's plan if the company allows that (not all do).
The alternative is to take it out and pay the taxes now. You may be eligible for one of several tax breaks, including five- or 10-year forward averaging, but in general, experts say, it's better to put off the taxes.
"Unless you need the money, you should either leave it in the plan or roll it over into an IRA," said Raymond Russolillo of PricewaterhouseCoopers in New York. That is true "9.9 times out of 10," he said.
Ed Slott, a CPA with offices in Rockville Centre, N.Y., agreed.
"The main consideration is, when will you be needing the money? Nobody would tap into a tax-deferred account if they didn't have to -- why break that growth pattern if you don't need the money?" he said.
Leaving the money in the company plan has several potential advantages. The plan may have attractive investment options; it most likely picks up the investment management and other fees; and you may be able to borrow your money if you need it, paying interest to yourself in repayment.
On the other hand, if you die and want your children or grandchildren to have the money, Slott pointed out, you're better off in an IRA. That's because most companies require non-spouse beneficiaries to take the money in a lump sum, and non-spouses can't roll it over into their own IRAs.
Also, if you want to move the money to a Roth IRA, you need to roll it over to a traditional IRA first. That means paying the taxes now, of course, but in some situations it's worth it. Taxes on conversions done this year can be spread over the next four years.
If you are taking cash, you may qualify for five- or 10-year averaging, though both of these are on the way out. The 10-year plan is available only to people born before 1936, and the five-year plan is repealed after 1999.
To qualify, the distribution has to be from a qualified plan, your entire plan balance must be distributed to you in one year, you must have been in the plan at least five years and be at least 59 1/2 years old.
The options are not true averaging, however, and have lots of twists.
Under the 10-year plan you are taxed using pre-reform 1986 tax rates for single taxpayers (regardless of whether you are married or not). Since those rates were as high as 50 percent, 10-year averaging is not as favorable as five-year for large distributions. The five-year plan uses current rates, which top out at 39.6 percent, though it also uses single-taxpayer rates.
Slott figures that because of the way the brackets are structured, 10-year averaging is best for distributions up to $116,340. Five-year is better from $116,340 to $133,256, then 10-year is better up to $332,751. Above that, five-year is better again.
Averaging was put in to ease the burden of receiving a big wad of cash in one year.
"If you take $100,000 of additional income and add it in all in one year, you are not going to create bracket creep, you are going to create bracket leap," Russolillo said.
But the deal is not as good as the name implies. Instead of taking a fifth or a 10th of the income each year and adding it to your regular income, you do a separate calculation.
You take a fifth or a 10th of the lump sum, figure the tax on it, and multiply that tax by five or 10. That's your tax, and it's due in the year you got the money.
If your lump-sum distribution consists of highly appreciated stock, there is yet another alternative that can be attractive. Under a special rule, you may take the stock and elect to pay tax on it at ordinary income rates, but only on that portion of the stock that represents its original cost to the plan. (There may also be a 10 percent penalty if you're under 55.)
The difference between that original cost and the current market value is called net unrealized appreciation, and you don't have to pay tax on that until you sell the stock. Then, when you do sell, you get capital gains treatment, so your maximum tax rate is 20 percent.
There is no penalty and no immediate tax, of course, if you roll the stock into an IRA, but withdrawals are taxed at ordinary income rates.
The twists and turns of pension planning are so numerous and so convoluted that consulting a professional is probably a good idea.
"They've got the (computer) programs and they know what to ask," Field said.