When You Exit With Big Sum, Step Carefully

Though hardly anybody ever complains about receiving a large amount of money, lump-sum payments can in fact be hard to swallow. Experienced financial advisers say they have seen the script played out many times over--the confusion, uncertainty and even fear that arise when somebody receives an unaccustomed big check.

The problems are legendary that can come with a bonanza from some outside source, such as an inheritance or a winning lottery ticket.

But it can be just as difficult to deal with a lump sum of money that was “your own” to begin with, as in the case of a payout from a retirement plan.

“Receiving a distribution from your retirement plan may be exciting, but it can be overwhelming too,” says the investment management firm of Scudder, Stevens & Clark Inc. in a booklet written for participants in its American Assn. of Retired Persons Investment Program.

“Depending on your age and the amount of time you’ve worked for this employer, your distribution could be the largest single cash sum you’ve ever received.”

Lump-sum payouts from company plans occur most commonly when people retire or otherwise leave their jobs.

There is no need to panic and make impulsive choices about what to do with the money, but the rules of the U.S. tax system do require that you make some decisions without indefinite delay.

One option that shouldn’t be neglected is keeping the money invested where it is, if that course of action fits your needs and your employer’s plan permits it.

If the money is going to be paid out, it can follow one of two channels--direct transfer to a new tax-deferred account, such as a new employer’s retirement plan or a bank or brokerage individual retirement account, or payment to you for your own use or rollover into an IRA or another pension plan.

Direct transfer from one custodian to another preserves the money’s tax-sheltered status.

“If you choose to receive the distribution directly, however, your employer must withhold 20% of the amount for federal taxes,” points out the investment firm of Kemper Securities in its newsletter Investor News.

“You have 60 days after receipt to roll that amount into an IRA, but you must make up the withheld 20% from your own funds.”

With a properly executed rollover, you owe no tax, but you will have to take separate action to get back the amount withheld, such as claiming a refund when you file your tax return for the year or reducing other withholding and estimated payments.

So at the very least, rollover withholding is likely to mean some extra work and a period in which some of your savings aren’t working for you earning either taxable or tax-deferred income.

You don’t have to choose specific investments in which to put your money as fast as you do a transfer or rollover.

For instance, if you move the money into an IRA at a mutual fund group, you can initially put it all in the group’s money market fund, and then take your time deploying it among other funds in the group.

The temptation may naturally arise to spend a lump-sum distribution on something you want, such as a car or long-postponed vacation. The decision not to transfer or roll over, however, means that the distribution will be subject to taxes.

If you are under age 59 1/2, that may mean a 10% penalty tax as well as current income taxes.