Your choices of distribution of your retirement benefits generally include a lump-sum distribution, an annuity, or rollover to a traditional IRA or a new employer's qualified plan. Each of these distribution methods has different federal income tax requirements; an understanding of these will contribute to your decision of how to take your distribution.

You may want or need to take an early distribution of your retirement benefits, but you should be aware of the tax implications and possible penalties before you make this decision. Alternatively, you may want to defer your retirement plan distribution; you can do this for a time before minimum distribution requirements kick in.

If, after exploring these sections, you still have questions on the tax consequences of your distribution option choices, call your tax professional for assistance.

Lump-Sum Distributions

Some retirement plans offer only a lump-sum payout at retirement. In this case, is it better to pay taxes at distribution or defer taxes by rolling over the amount into a traditional IRA? A traditional IRA can serve as a place to continue the tax-deferred sheltering of money from your employer retirement plans. If you have your employer plan transfer the money directly into a traditional IRA, i.e., a direct rollover, no taxes are due until you begin to withdraw the money.

A lump-sum distribution is a distribution of all the money in your retirement plan in one large lump-sum. A payment qualifies as a lump-sum distribution if it meets the following requirements:

• The distribution is payable on account of death, attainment of age 59½, or separation from service.
• All the contributions and earnings in all your qualified retirement plans (i.e., pension, profit-sharing, or stock bonus plans) are paid out.
• The payment is made in one taxable year.

You will generally have three choices if you go this route:

1. You can roll all or part of it into a traditional IRA or Keogh or other qualified plan and defer paying income tax.
2. If your modified adjusted gross income is $100,000 or less (and you are not married filing separately) you can convert a traditional IRA into a Roth IRA. You are required to pay tax on the deductible and pre-tax contributions and any earnings on the date of the conversion. The 10% early distribution penalty does not apply on the conversion.
3. You can decide to keep money and pay income tax on it. If you decide you would like to keep the entire lump sum, you may qualify for ten-year averaging when paying the tax. This is a complex area of the tax law that should be deferred to a professional. In a nutshell, you may be able to reduce the ordinary income tax you pay on the distribution by using this method to figure your tax.

Ten-year averaging

If you receive a lump-sum distribution, you may have the option of using special ten-year averaging methods of computing your income tax in the year you receive the distribution. If you attained the age of 50 by January 1, 1986, ten-year averaging and the existing capital gain provisions are available to you. You may then elect ten-year averaging treatment using the 1986 tax rates.

The ten-year averaging formula is computed separately from the tax on your other income. You pay the tax only once. You do not pay the tax over the next ten years. Once you choose your option and figure the tax, it is added to your regular tax figured on your other income. If you qualify, complete IRS Form 4972 to compute the special tax. You must meet several requirements to qualify for this special tax treatment:

1. The payment must be on account of termination of employment or death.
2. The entire balance in your account must be distributed as a lump-sum.
3. Ten-year averaging must be used for all lump-sum distributions you receive from all qualified plans in one calendar year.
4. Election of the ten-year averaging method can be made only once.
5. You must have been in your plan for five years before the year of distribution (unless the distribution is on account of death).

SUGGESTION: The portion of the distribution attributable to pre-1974 participation may be eligible for a capital gains tax computation. If you have pre-1974 accumulations, contact your tax professional to discuss these rules.

IMPORTANT NOTE: Ten-year averaging is not available for distributions directly from IRAs.