Financial Advice Q&A

Occasional Visitor
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Question
How are my taxes impacted by taking a lump sum distribution from a retirement plan?
[ Edited ]

I have decided to retire this week and receive a partial lump sum distribution plus monthly stipend. I also intend on going back to work with a different company. I work for a municipality. I want to use the money to pay down debt. The PLSD will be taxed 20% with possibility of another 10% fee. I am concerned how the money will effect my income tax in 2015 and want to make other investments, gifts, etc to lower that tax. What are some of my options other than an IRA? The amount I will receive is possibly $40,000 plus $1300 or $60,000 plus $1100 monthly.

Other Answers: 1
Community Manager
Posts: 1,009

Whoa!  “I have decided to retire this week…”

 

There’s a phrase virtually guaranteed to give any financial planner a serious panic attack! Retiring will ideally be the result of thoughtful and careful planning – not a spur of the moment decision. So hopefully you’ve already done that and just decided this week to pull the trigger sooner than you originally intended…right?

 

In either case, here’s how your retirement plan withdrawal will impact your taxes for the year. 

 

Income Tax Calculation
The amount you take as a lump sum plus your monthly pension payments will be added to your other taxable income for the year and the total will be taxed according to the bracket you land in.  For instance, if you take the first option you listed, you’ll be adding $40,000 plus about $7,800 ($1,300 x 6 months) to your other taxable income for the year. The tax will then be calculated on the total and if there’s a 10% penalty on the lump sum, it will be added in as well. If you have more withheld throughout the year than the total tax due, you’ll get a refund.  If you don’t have enough withheld, you’ll have to write a check at tax time.

 

Tax Reduction Strategies
To reduce your tax bill you’ll have to find ways to reduce your taxable income. While it’s generally best to get with a CPA or other qualified tax preparer to decide what to do in your specific situation, here are a few options to consider:

 

  • Take investment losses. Investment losses that aren’t used to offset investment gains can be used to reduce ordinary income. But there’s a limit of $3,000 per year and you have to recognize the losses (sell the investments) to take them.

  • Increase itemized deductions. Itemized deductions like real estate taxes, mortgage interest, and charitable gifts, to name a few, can help reduce your tax bill by reducing your taxable income. In some cases you might be able to drive this year’s taxable income down by paying next year’s expense this year as well.  Just know though that taking this approach might land you in a similar spot the following year. Also, it’s important to know that deductions like this don’t result in a one-for-one reduction in tax.

  • Delay income. If you can wait until next year to withdrawal your taxable retirement plan money, you might end up paying less tax on it because you won’t have this year’s income from employment added into the mix.  Lower overall income could result in a lower overall tax bracket and therefore lower overall taxes.

So again, your best approach here to minimize taxes will be to get with a tax pro and discuss your situation. Hopefully these ideas are a good start for that conversation.

 

Thanks so much for your question and Happy Retirement!

 

Scott

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