 Retirement-plan
distribution land mines
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You've built up a nice nest egg and are closing in
on the date when you plan to retire. You have a lot of decisions
to make about your retirement plan accounts. For example, should
you roll over money from your 401(k) plan into an IRA?
To figure that out, all you need to do is call up your financial
adviser, who will know exactly what to do, right?
Not necessarily. The rules for
retirement-plan distributions are so complex that even full-time
financial professionals often botch things up for their clients,
says CPA Ed Slott, who gives education seminars on IRA-distribution
planning and estate planning to financial advisers.
Sometimes the botch occurs during the rollover process
-- which can happen if you don't do a "direct rollover,"
also known as a trustee-to-trustee transfer -- and instead take
a distribution and miss the 60-day deadline to move the assets into
another retirement account. In these circumstances, plan assets
are also subject to 20-percent mandatory withholding for tax purposes.
So if you don't happen to have extra money to cover the amount withheld,
you're trapped.
Slott lives by a few important rules: Don't cook bacon
when you're naked. Don't get into fights with ugly people (because
they have nothing to lose). And don't give money to Uncle Sam before
you have to. "Everybody knows that to build real wealth, the
key is to keep your money from the government, away from being taxed,
for as long as possible."
That means you need to know where the land mines are
buried with respect to retirement plans. The land mines, it turns
out, are all over the place. Here's a road map that outlines where
a few of the biggest ones are -- those that can cause your nest
egg to blow up in one bad move.
Company stock in your 401(k)
plan
If you own a lot of employer securities in your retirement plan,
you may be eligible for a huge tax break. It's called "net
unrealized appreciation," or NUA, and it applies only to company
stock. Top executives and employees who have worked for a company
for many years can greatly benefit by following these steps -- or,
conversely, lose out by making missteps.
To qualify, you must be eligible to take a lump-sum
distribution from the plan, and all the plan assets must vacate
the plan within one calendar year. The 20-percent mandatory withholding
imposed on plans does not apply to NUA.
Here's what happens: In your imaginary account you
have $1.5 million in assets, with two-thirds of that in company
stock. (It's never a good idea to have too much of your nest egg
in company stock, but let this ride for illustration purposes.)
You do a trustee-to-trustee transfer of the $500,000 that you have
in mutual funds into a direct-rollover IRA.
Meanwhile, the shares of company stock should
be transferred to a taxable brokerage account. "Don't sell
the shares in the plan (first), because that negates the benefit,"
says Slott.
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