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Take a Lump Sum Distribution

Although it may be tempting, taking cash from your retirement plan is rarely a good idea. In fact, you may lose nearly half of your hard-earned investments to taxes and penalties!

Watch Out for Uncle Sam

If you aren't careful, the IRS could be the biggest beneficiary of your retirement plan investments. Taking a lump sum distribution triggers the mandatory 20% withholding for federal taxes, which means your savings go directly to Uncle Sam. On top of that, a lump sum distribution could bump you into a higher tax bracket that would slap you with even higher state and federal taxes at year-end.1 If you are younger than age 59½, your distribution may also be subject to a 10% early withdrawal penalty.

Taking Cash Can Be Costly

Here's what's left of a $20,000 cash payout:*
  • 10% early withdrawal penalty may be assessed if you are under age 59½.
  • You'll owe federal, state and local taxes on the entire distribution at year-end, since it will be considered part of your ordinary income. At the time of your disbursement, your employer must withhold 20% toward your federal tax obligation.
  • As you can see, 43% of the payout has been eroded by penalties and taxes.

Taking Cash Can Be Costly
* For illustrative purposes only. Assumes a 28% federal tax bracket. State and local taxes vary. Depending on your tax bracket, the federal tax you'll owe at year-end may be higher.

Stretch Your Investments Instead

Rolling your retirement plan assets into an IRA allows the bulk of your investments to continue growing tax-deferred.

If you've already received a cash distribution from your plan, it may not be too late! You have 60 days to move the money into an IRA or a new qualified employer retirement plan. To avoid all taxes and penalties you will need to make up for the 20% mandatory withholding with out-of-pocket money. You can recover this money when you file your federal tax return.

Advantages of a Lump Sum Distribution

  • Immediate, unrestricted use of your money.

Disadvantages of a Lump Sum Distribution

  • Savings lose tax-deferred status.
  • Distribution is reduced by 20% mandatory withholding.2
  • Distribution may be subject to a 10% early withdrawal penalty as well as additional federal, state, and local taxes.
  • Lose the flexibility to move into a qualified plan or IRA (after 60 days).

Rolling your money into an IRA or taking a distribution are just examples of the options you can choose for your old retirement plan. Each option has different advantages, disadvantages, investment options, and fees and expenses, which should be understood and carefully considered. Investing and maintaining assets in an IRA may involve higher costs than those associated with employer-sponsored retirement plans. We recommend that you consult with your current plan administrator before making any decisions regarding your retirement assets.

1 Distributions are taxed at applicable federal and state tax rates at the time of the distribution.
2 You can make up the 20% that was withheld by your employer for federal taxes out of other savings and roll the entire amount into an IRA if you do it within 60 days of receiving your distribution. Then you can file to recover the original amount withheld by your employer when you file your federal income tax return.

Here's how a $20,000 cash payout would be broken down. The 10% early withdrawal penalty equals $20,000. $5,600 would go towards federal income tax (assuming a 28% tax bracket). $1,000 would go to state and local income tax. Your savings are reduced to $11,400 after taxes and penalties.

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