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Company Pension Plans

Remember when we discussed early withdrawal penalties for 401k plans and IRA's?

Well, the same 10% penalty that hits early withdrawals from individual retirement accounts applies if you receive money from a company plan early. Although early is defined in the law as before you reach age 59 1/2, an exception to the penalty means most employees can take penalty-free payouts starting the year they reach age 55. The age 55 exception applies if you get the payout because you leave the job-which, of course, is usually the case. The penalty stretches to age 59 1/2 only for withdrawals while you're still on the job. (Note that the exception applies in the year you reach age 55; you don't have to be 55 when you leave the job and get the money as long as that birthday comes by December 31.)

Because the point of retirement plans is to help make sure you'll have money to live on in retirement, the 10% penalty is designed to encourage you to roll over early payouts into an IRA. Such a rollover lets you dodge the 10% penalty, but once inside the IRA, the money is still tied up until you're at least 59 1/2.

As with 401(k) plans, there are other exceptions to the early-withdrawal penalty. At any age, it does not apply if:

* You are disabled.
* The distribution is made to your beneficiary after your death.
* The payments are made in roughly equal installments over your life expectancy or the life expectancy of you and your beneficiary.
* The money is used to pay medical expenses in excess of 7.5% of your adjusted gross income.

Retirement Income

If you receive regular payments from a company pension or annuity, tax may or may not be withheld. The same goes for withdrawals you take from a regular IRA. Believe it or not, it's up to you whether part of the money will be taxable.

If you want to hang on to a bigger portion of your retirement checks, all you have to do is file a form with the payer. The company that pays your pension or annuity should periodically remind you of your option to block withholding and tell you how to do it.

Note, though, that withholding on these payments isn't necessarily a bad thing, it stretches the tax bill over the entire year rather than leaving the bill to be paid all at once at tax time. Withholding might make life easier if the alternative is to make quarterly estimated tax payments, which are discussed later. If you allow it, the amount held back from pension and annuity checks is based on information you provide on a Form W-4P, just as withholding on wages is controlled by a Form W-4.

Pension Payout Trap

Don't get tripped up by the withholding rule that can sting employees who get lump-sum payments from company retirement plans-the kind of payment you might receive not only when you retire, but also if you quit or are laid off.

Not so long ago, withholding on such payments was voluntary. The best course for most taxpayers, in fact, was to say "no'' to withholding, take the money and roll it over into an individual retirement account (IRA). Doing so within 60 days meant no tax was due on the payout, so there was no need for withholding.

Now, however, if you take the money, 20% of it is automatically withheld for the IRS. That's true even though a rollover will still allow you to avoid the tax. In that case, the IRS would have the money you don't owe until you file a tax return for the year and receive a refund. What’s more, you’ll have to make up the 20% from other funds in order to make a complete rollover.

Congress set the 20% withholding provision to raise money-an estimated $2 billion over five years. But only unsuspecting taxpayers will pay it because there's an easy way around withholding: Simply ask your employer to send the money directly to your rollover IRA. As long as the money doesn't pass through your hands, there is no withholding.

Published Nov 29 2006, 04:15 PM by moneycoach
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