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It’s Costly to Change Mind on Putting Funds in IRA

QUESTION: Last August, I received a lump-sum distribution from a pension plan. I rolled it over into an individual retirement account. Now, I’ve changed my mind and would like to withdraw the proceeds and use the 10-year averaging option instead. I read somewhere that I can do this as long as I do it by the due date of my tax return--April 15. Am I right? And if I’m not, what is the penalty for withdrawing the money?--R. A.

ANSWER: You’re wrong. Once you put a lump-sum retirement distribution into an IRA, you must leave it there. If you remove the money, you will be prohibited from reducing your tax bill by income averaging and you likely will be slapped with a large penalty.

The exact penalty will depend on how old you are. If you are under age 59 1/2--the earliest you are allowed to withdraw IRA funds without penalty--the penalty is 10% of all money withdrawn.

If you are at least 59 1/2, you do have the right to withdraw some IRA money. But withdrawals are subject to very strict guidelines. If your withdrawal exceeds the annual allowance--which is figured according to the amount in your IRA and your life expectancy--you will incur a 15% penalty on any excess amount you withdraw.

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In other words, if you’re now unhappy with your decision and are determined to withdraw all or part of the money regardless of the tax consequences, either contact the Internal Revenue Service, see an accountant or go to your local IRS office and get forms and pamphlets telling you precisely how to figure your annual withdrawal limits.

How, you may wonder, will the government ever know? Whenev er someone receives a lump-sum pension distribution and elects to roll over the money to an IRA, he or she must put that decision in writing. Once that document is signed, the decision is irrevocable.

You also should know that once you choose to roll over the money to an IRA rather than putting it in your new employer’s pension plan or paying the tax immediately, you lose the right to reduce the tax on the lump sum through income averaging.

Tax reform, incidentally, changed the rules governing income averaging. Under the new law, if you were younger than 50 at the start of 1986, you cannot apply income averaging to a lump-sum pension distribution until you are at least 59 1/2 years old.

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Someone who was at least 50 years old in 1986 and receives a lump-sum distribution from a pension plan is entitled to income- average, and in fact now has the choice of two averaging methods: 10-year averaging using 1986 tax rates or five-year averaging using the applicable tax rate for the year that averaging is claimed.

The only way to decide which is best is to calculate the tax each way and compare the results.

Q: In a recent column you discussed the possible consequences of turning in tax cheats. I am not interested in any monetary award. But could you please tell me who I should contact?--B. B.

A: If you have information you think would be valuable to the IRS, you can either give it in person or in writing. When writing, address correspondence to the assistant commissioner, criminal investigation, OP:CI:INV:I, Internal Revenue Service, Washington, D.C. 20224.

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If you prefer to hand over your information in person, you may contact the assistant commissioner’s office in Washington or visit the criminal investigation division of any IRS district office.


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