It doesn?t pay to take big check from employer

The biggest check you could ever get from your employer is one you should turn down.

When you retire, quit, or are laid off or fired, you can take the funds in your retirement plan in a single check called a lump-sum distribution. If you lose your job, it may be tempting to take the check, but consider the consequences:

??Your retirement savings will no longer be able to grow on a tax-deferred basis. The entire amount will be subject to federal and state income taxes in the first year of the lump-sum distribution.

? Because you are receiving all of your retirement savings in a single check, it is likely to bump you into a higher tax bracket.

? Your employer is required by law to withhold 20 percent of the funds.

? Your funds may be subject to a 10 percent early withdrawal penalty.

? If you spend the money, it?s unlikely you will have sufficient funds for when you retire.

Avoid Penalties, Taxes

Instead, you can roll over the funds into either another employer?s plan or an Individual Retirement Account (IRA). An IRA rollover will preserve your retirement savings, allow your savings to continue growing on a tax-deferred basis, and allow you to avoid penalties.

If you are laid off, quit or are fired, your former employer may be willing to hold your funds until you find new employment, so you can transfer your funds to a new plan without consequence.

You can also continue the deferred tax advantages of a qualified plan and avoid penalties when you take out and receive a lump-sum distribution by re-investing the funds in an IRA or another employer?s qualified plan within 60 days.

However, your former employer will still withhold 20 percent of your retirement savings. The 20 percent withheld would be treated as a distribution, which would be subject to income taxes and possibly penalties.

By rolling over your funds directly from your qualified plan into another qualified retirement plan or IRA, your retirement savings can continue to grow on a tax-deferred basis. Because no taxes are due until funds are distributed, earnings can continue to grow on a compounded basis, which can significantly increase their value over time. In addition, when funds are taxed, they may be taxed at a lower rate than they would be today, since most people are in a lower tax bracket after they retire.

Rollover Options

Today, employees who are changing jobs can roll over funds from one type of qualified retirement plan to another, but they can also roll over their funds into an IRA.

Employees working for non-profit organizations typically have a 403(b) retirement plan, those who work for a government agency usually have funds in a 457(b) plan and those working in the private sector often have their retirement savings in a 401(k) plan. Funds can be transferred between any of these plans when employees change jobs.

However, transferring funds to a rollover IRA will give you greater control over your investments. You can invest your IRA funds, including into any of the thousands of mutual funds that are available, stocks and bonds, exchange traded funds (ETFs) and other investments. Retirement plans sponsored by employers typically offer only a limited number of investment options.

A rollover IRA is easy to set-up and easy to administer. Since employees generally change jobs frequently today, you may have several different jobs, and several different retirement plans, before you retire. If you have a rollover IRA, you can transfer funds from any number of plans into a single account.

Transferring funds from one employer-sponsored plan to another is typically more difficult. Regardless of which rollover option is chosen, however a rollover it will yield tax and savings advantages over a lump-sum distribution.

David A. Ross, MBA is a Certified Financial Planner with Ross Financial Planning in Murfreesboro. He can be reached at 615-217-2100.