How do you get your money out of a retirement plan? When can you get it out? What kinds of penalties, or taxes, are involved? And how is the payment of benefits different depending on how, and when, you take them? We break it down for you, to give you the gist without being overwhelmed.
How do you get your money out of a retirement plan? When can you get it out? What kinds of penalties, or taxes, are involved? And how is the payment of benefits different depending on how, and when, you take them? We break it down for you, to give you the gist without being overwhelmed.
This episode focuses on the letter D: Distributions. How do you get your money out of the plan? When can you get your money out? What kinds of penalties, or taxes, or anything else, is involved? How is the payment of your benefits is different, depending on how, and when, you take them? Let’s talk it through.
Episode D – Distributions First, what do we mean by distrib? Money that’s contributed to a QP goes into a trust, and is invested for the sole ben of the ptps – this is one of the many rules we mentioned in Episode A.
· In general, if you’re actively working, you don’t have access to your QP benefit. There are exceptions, talk about in a bit, but overall, that ben is in there for when you retire. So, in order to get your benefit out, there generally needs to be a ‘distrib event’ – something that happens that triggers a distribution. Things like … you quit. You retire. You become disabled. At this point, you can likely take a distribution from the plan. I say ‘likely’ because some plans require you to be a certain age, regardless of whether you’re active or not – I still have a benefit back at one of my former employers, because I can’t get it until I’m 55. Things like that… for smaller plans, there’s usually not this age requirement – so once you aren’t active, you have access to your benefit, and can take a distribution.
· At that point you’ll get a summary of all of your choices from the administrator of the plan, and you’ll be asked to choose what you’d like to do. In a defined contribution plan, your benefit is the sum of all of the contributions and investment earnings through your career – so your distribution amount would be your investment account. There are usually a lot of different options to choose from – you may be able to choose a lump-sum, which is a one-time payment that you can roll into an IRA, take as income and get taxed, or a little of both. Once you’re paid this lump sum, there’s nothing else due to you in the plan. You can also choose options that will pay you over your lifetime – 401(k)s used to not have to offer this, but now with the SECURE act, they do, which is a great way to have a constant payment over your lifetime. A life annuity would make payments to you over your lifetime, and if you pass away, nothing else is paid. Compared to the lump sum, this is a bit of a risk – for example, you may have the option of a $1M lump sum, or $50,000 per year for your lifetime. If you live longer than 20 years, you’re ahead of the game! But what if you pass away after 1 year? Only $50k is paid, and your spouse and benes are out of luck. Def pros and cons to each…. There are other distrib that you can take – joint and survivor benefits will pay you a set amount for your life, and if you pass away, a portion will be paid to your spouse or beneficiary. A Certain and Life annuity will pay you for your lifetime, and will guarantee payments for a certain # of years. So, in our example above, if you elected a 5 year Certain and Life for $50,000, and you passed away in year 1, your spouse or beneficiaries will get the remaining 4 years. All of these options are specified in the plan document – your plan may have all of these and more, or it may not have all of these…. It’s up to the sponsor.
· FUN FACT – vast majority of people will take the lump sum distribution – not surprising. A 2016 Harris poll of retirees shows that 21% of participants who took a LS had it depleted in 5.5 years!
· For whatever form you elect, you’ll be taxed as the dollars go into your pocket. If you choose the life annuity for $50k, you’ll have $50k included as income every year and taxed every year. If you take the whole $1M, again, you’ll have that included as income and taxed in the year you take it. And, if you’re not 59 ½ yet, you’ll also have a 10% excise tax on that lump sum – so think carefully about whether it’s worth it!
· What if you don’t want to pay taxes? Then you can roll that lump sum into an IRA, and you’ll have a qual IRA. As you take money out of that, you’ll be taxed – but until then, it’ll grow tax free. It’s a great way to defer taxes, but if you haven’t taken any payments by the time you’re age 72, the IRS is going to start making you take payments – called Required Minimum Distributions. They aren’t huge – at age 72, it’s only about 4% and it goes up as you get older. But it’s something to know. We talk more about IRAs in Episode S – Stretch IRAs, which are no longer available as a result of the SECURE Act, and could result in some big taxes paid by your beneficiaries – tune in to that episode to hear some options with getting around that.
· Everything we’ve talked about so far has to do with plain old cash. What if there’s other investments in the plan that you can take? Insurance for example – what if part of the investment in the plan is an insurance policy on you? Well, you have options with that too – if you don’t need the policy, it would be surrendered, and whatever the cash value of that policy is would be added to your other funds. Then you’d have the same options as we already talked about. If you want the policy? Well – you have the policy distributed to you, and you become the owner. A few things about that – you’d pay taxes on the cash value of that policy, because you’re getting it as a distribution – just like the regular investments above, the cash value would be counted as income and taxed. And you’d have the 10% penalty if you’re not 59 1/2. But you’d have insurance – and then it’s a regular ins policy – if there are premiums due, you would need to pay them. You could take loans on the cash value. You’re a regular policyholder at that point.
· What about temp distributions – loans, or withdrawals? This generally depends on the plan. Some plans, like 401(k)s or profit sharing plans, will allow loans of up to 50% of your benefit and up to a certain amount – you’d then pay back the loan to yourself. I took a loan on my 401k when I bought my first house – it was a great way to have access to cash and the interest that I paid back went to me and not a bank. There’s no tax implications because you’re borrowing the money, and you’re going to pay it back – so it hasn’t been fully distributed to you. These plans sometimes allow withdrawals too – either hardship wdrls if something unexpected occurs and you need cash, or “insvc” wdrls if you’re over 59 ½ and want to start taking some of your retirement benefits. W a wdrl, when you get the $, you’re taxed as income - the $ is being distributed to you, and you’re not paying it back, so it’s counted as income for you in the year you get it. For a defined benefit plan, cash balance, fully insured – the bigger plans – loans and wdrls are usually not allowed at all.
· FINAL FUN FACT: Most well known pension plan around, SS, doesn’t offer lump sums for retirement – just annuities paid over lifetimes. There IS an option to take 6 months of pmts as a LS for some – be careful, push your retirement date back 6 months when they calculate your monthly pmts, so your pmts in the future will be less.
· Wrapping it all up – if you’re actively working, you may have access to some of your funds via a loan or wdrl, but usually distribs are made after a distrib event. At that point, you’ll have help from the plan administrator and from us to see what your options are, the pros and cons of each, and the dollar amounts associated. Once you make this election, it’s done – you can’t go back and re-elect, so choose carefully! Get all of the information, and make sure you make an informed decision.
· Want to hear more? The other episodes mentioned here are A (ABCs of ret plans ), S (Stretch IRAs)
Have any questions? Shoot me an email at MRS@gmail.com. Thanks for listening in – and have a great rest of your day.