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Transitioning pensions from a company-sponsored retirement plan

There is a long tradition of U.S. employers providing retirement plans for their employees. This has long provided value for both groups, since employees can look forward to a good source of income after they retire if they take full advantage of the programs in place and employers can take a tax deduction for amounts they put into qualifying plans. Company-sponsored retirement plans give employers a distinct advantage in attracting and retaining quality employees, and the plans also provide employees with a convenient way to maximize their savings for retirement.

Recently, many headlines have announced numerous pension problems, but in spite of these articles on the decline of employer-sponsored pension plans, employer-sponsored plans are still available and there is a large percentage of the population that will be transitioning benefits from their company plan to individually sponsored retirement investment vehicles. The largest segment of people that will be transitioning their pensions in the next several years will be the baby boomers, which make up 79 million Americans born between 1946 and 1964.

Consider the following statistics: A man retiring today at age 65 can expect to live at least another 15.9 years longer, while the life expectancy of a man retiring in 2020 will be 17.6 years, according to the U.S. Census Bureau. A 65-year-old woman today can expect to live another 19.5 years, and 20.6 years by 2020. It is imperative that these individuals know the proper way to transition their company plans, and what types of company plans are eligible for rollover to an IRA. In this article we will cover the following investment options, defined benefit plan lump sum (pension), defined contribution plans (401(k)) and employee stock plans, and analyze the best ways to roll company-sponsored plans over.

Pension lump sum payment versus life annuity plans

One way to take control of your retirement assets is with a lump sum payment. First, the company-sponsored plan can be rolled over into an IRA to preserve the tax-deferred status. This then creates a pool of assets that can be accessed if the need arises. The benefit of taking a lump sum payment is that the assets can be passed to a spouse or non-spousal beneficiary upon death of the recipient and there could be an increased chance to achieve greater returns since the money can be placed in stocks, bonds and other investment vehicles. This option is often a good choice for an individual who plans to go back to work and doesn't need immediate income.

A life annuity plan allows for a fixed stream of payments for life. The payments are guaranteed, but only by the claims-paying ability of the insurance company or institution making the payments. This plan is not subject to market risk, like the lump sum payment, and the recipient will receive a greater benefit if he or she outlives the projected life expectancy. The disadvantage to this plan is that the distributions do not adjust for inflation, so buying power deteriorates as time passes and there is no pool of assets to access if the need arises. Most of the time these plans do not allow for the transfer of assets to a beneficiary, but sometimes participants will have the option to take a lower monthly payment for their lives to assure their spouse or beneficiary continues to receive the same or a smaller payment upon death of the participant.

It can be difficult choosing between the two plan options above. Many factors need to be reviewed in order to choose the most appropriate one. These factors include health and the likelihood of outliving one's life expectancy, the desire to pass assets to a spouse or heir, the need for asset flexibility and control, investment experience and tolerance for market risk and other sources of income in retirement.

Defined Contribution Plans (401(k))

This type of plan allows participant contributions and employer match contributions to be rolled over to an IRA to preserve the tax-deferred status. After-tax contributions can also be rolled over or paid out to the participant. Once rolled over, the IRS has specific tax rules regarding the withdrawal of after-tax contributions from an IRA that must be considered before deciding to roll over after-tax assets. Participants can typically choose to roll over shares of any company stock they may hold in the plan, or they can liquidate the stock and roll over the cash proceeds. Participants may also want to consider an option the IRS allows with company stock shares called Net Unrealized Appreciation, which we'll touch on next.

Employer stock and net unrealized appreciation

Upon separation from service, participants have the option to take a lump sum distribution of company stock from a 401(k) plan and pay ordinary income taxes only on the stock's cost basis, which is the average amount a participant paid for the shares over time. But the difference between the basis and the fair market value -- the net unrealized appreciation -- is taxed at long-term capital gains rates only when the stock is sold regardless of the holding period. This can sometimes be a better option than rolling the stock into an IRA where all of its value will eventually be taxed as ordinary income.

A couple things to note: The lump sum distribution of company stock from a 401(k) plan is subject to a 10 percent premature withdrawal penalty if under the age of 55 at the time of separation. Also, this may not be the best option for someone under the age of 59.5 who needs as much money as possible in an IRA for purposes of calculating substantially equal periodic payments (IRS rule 72(t)).

Seek advice

When transitioning assets from a company plan to an IRA, the distribution instruction paperwork can sometimes be complicated and mistakes can equate to undesirable taxation. Make sure to enlist the help of a financial advisor. There are plenty of resources on the Internet and numerous books dedicated to the subject matter, but a financial advisor will be able to analyze your particular situation and guide you in the right direction.

About Coghlan Financial Group

Coghlan Financial Group, LLC regularly holds free educational seminars for companies and their employees, as well as small business owners, on the facts and questions of retirement planning. The questions come easily but the answers don't until further investigation and more in-depth planning is done. So much depends on the individual, his or her needs and goals, his or her retirement money available and the company plans and retirement strategies. In addressing these common concerns and in working with employees, Coghlan Financial Group has developed a program called the "Retirement Planning Review." This is a comprehensive review tailored to each individual that provides a future retirement income analysis and helps individuals determine whether or not they are on track to meet their goals.

Partners of the Coghlan Financial Group are financial advisors with Securities America Advisors Inc., and specialize in financial planning, retirement and estate planning, risk management, portfolio design, asset management services and financial goal integration. For more information, visit www.coghlanfinancial.com or call (800) 884-5121.

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