What is a Lump Sum Distribution?
The definition of a lump sum distribution can vary by company, and from person-to-person. This article, for simplicity’s sake, is written under the assumption that you are receiving (or will soon receive) a lump sum distribution of your 401k or other retirement accounts as defined under current tax law. This means that you will either receive a single payment or several payments over the course of one year, either of which may include stock from an employer stock distribution plan.
Lump sum distributions can be complicated and extremely confusing-even for accountants and tax professionals, so before you meet with your accountant and financial planner, here are some answers to basic lump sum distribution questions:
Question: I was born after 1935, and I’ve heard that laws concerning lump sum distributions are stricter for those in my age bracket. What do I need to know about this to make informed financial decisions?
Answer: Anyone who wants to liquidate their accounts by taking lump sum distributions is required to pay taxes. You did hear correctly, however, that people born before 1936 face slightly less rigid restrictions on their lump sum distribution options. For the rest of us, here are a few things to consider:
Consider rolling over your IRA – this will allow you greater investment flexibility, and more control over your funds-in most cases than the current lump sum tax laws allow.
You must declare your lump sum distribution as income, which may put you in a higher tax bracket, thus increasing the amount of taxes that you will end up owing. This is one of the many reasons why an IRA rollover should be an option to consider.
There are exemptions that you may be able to qualify for, but these, like the definition of what constitutes a lump sum distribution, can vary, and it is best to see your financial planner determine if you are eligible for any exemptions.
Question: I am self-employed. Am I eligible for a lump sum distribution?
Answer: Those who are self-employed are not able to treat their retirement account liquidation as lump sum distributions unless they are permanently disabled, over the age of 59, or deceased.
Question: I was born before 1936, what are my options for lump sum distribution?
Answer: You qualify for more options than any other age bracket, so congratulations! That being said, here are a few of those options:
If you have any distribution that you can attribute to before 1974, you have the choice of paying a 20% capital gains tax and use either of these methods for balance.
Using the 1986 rates for single taxpayers, you can use ten year averaging for all or part of your lump sum distribution.
You can report all or part of your lump sum distribution as ordinary income on your taxes. For most people, this is not the best option to exercise, but it is still an option for you to use if you feel that it is to your benefit to do so.
Lump Sum Distributions: Becoming More Informed
Now that you know some of the basic facts about lump sum distribution, you can see for yourself why this is such a complicated issue. The sooner that you educate yourself with the help of your financial planner and other resources, the sooner you will be able to make wise decisions about financial issues like this one that can have a tremendous impact on your financial future.