An innovative retirement plan, the 401(k) is the primary savings vehicle for more than 20 million Americans having more than $500 billion for their safe and secure retirement. By 2006, this total is predicted to grow to $2 trillion.

Like others, you're counting on your 401(k) to make your retirement comfortable and secure. Yet, you likely have concerns about the most advantageous way to handle distribution of your 401(k) without paying unnecessary tax penalties.

For example, John and Betty (an actual couple, but fictitious names) are in the 50- to 60-year-old age group. They both participate in tax-sheltered programs where they work. And, they're concerned about having enough funds for retirement. John has a tax-deferred 403(b) program with his educational institution employer, and Betty has a 401(k) with hers. As they evaluate their retirement plans at this point in their lives, they plan to leave their tax-sheltered funds in their employers' programs when they retire.

Betty explains, "My main concern is simple: having enough to draw on, if possible, without using up the principal to supplement social security and my pension and still provide a level of income close to what I now have."

Before making decisions affecting taxation of your 401(k) money, review your options with a qualified tax adviser. And, the following frequently asked questions about 401(k) withdrawal options, and the responses, can help you make an informed decision as you retire and, perhaps, save you money.
     Though an annuity
     provides a guaranteed
     lifetime benefit,
     it is a fixed benefit
     with purchasing power
     reduced each year
     by inflation.

When I retire what happens with my 401(k) program?
When you retire anytime after age 59½, you can withdraw all the money in your 401(k) account subject to your plan's vesting schedule. Review and understand the options that may be available for distribution of your 401(k).

What distribution options are available for my 401(k)?
Not every 401(k) plan offers every option. In fact, in many 401(k) programs, the retiree must take a lump sum distribution. John and Betty are fortunate that their employers' programs don't require them to withdraw their funds when they retire. Other plans may offer a lifetime annuity, continued participation in the program after retirement, or an IRA rollover.

Before making
affecting taxation
of your 401(k) money,
review your options
with a qualified
tax adviser.
What is a taxable lump sum distribution?
If your plan requires you to take your 401(k) in a lump sum distribution, or if you elect to take a lump sum, you will owe income taxes on the full amount. No matter what your tax bracket, 20% of your distribution will be withheld for federal taxes. If you are younger than age 59½, you may have to pay a 10% early withdrawal penalty. However, after age 59½, you may, under current tax laws, be able to lower your tax rate by using "
five-year averaging."

Your tax adviser can explain how five-year averaging may benefit your particular tax situation.

Can I withdraw funds from my 401(k) if I retire before I reach age 59½, say at age 55?
The truth is, you can withdraw funds from your 401(k) anytime you leave a company no matter what your age. You will, however, owe withholding and, if you are younger than age 55, a 10% withdrawal penalty. If you are age 55, leave the company, and take a lump sum distribution, you will pay no penalty, only the income tax. The tax code says that no penalty applies to distributions "made to an employee after separation from service after attainment of age 55."

No matter what
your tax bracket,
20% of your 401(k)
will be withheld
for federal taxes.
Is a lifetime annuity advisable for my 401(k)?
Some 401(k) plans offer the option of receiving your distribution as a lifetime annuity, purchased from a private insurance company. This annuity will pay you a monthly benefit for your lifetime. If you have established a joint-and-survivor annuity, you and your spouse will receive the monthly payment for your lifetimes. You cannot change the annuity once you start it.

Though an annuity provides a guaranteed lifetime benefit that could amount to more than you paid into your account, it is a fixed benefit with purchasing power reduced each year by inflation. Further, once you and your spouse (if joint-and-survivor annuity) die, the annuity ceases, leaving nothing for any beneficiaries of your estate.

Annuity payments are subject to ordinary income tax. For example, if your annuity pays you $1,000 a month beginning January 1, 2000, you will owe taxes on the $12,000 annuity income for the year.

Is it possible to continue my 401(k) participation when I retire?
If your plan doesn't require you to take a lump sum distribution when you retire, you may decide to leave your funds in the program and continue to participate until you reach 70½, when you must begin withdrawing funds. Or you may decide to withdraw only part of your money. You will have to pay withholding taxes only on the amount you withdraw. As a rule, most plans require that you have at least $3,500 vested in your account to continue to participate when you retire.

Continued participation in your employer's 401(k) program is a sensible choice if you like the investment options it offers and if the plan allows you to withdraw funds as often as you need after you retire.

What happens if I decide on an IRA (individual retirement account) rollover for my 401(k)?
If you decide to roll your 401(k) into an IRA, your money will continue to be sheltered in a tax-deferred account and will avoid the 20% federal withholding. You can withdraw money as you need it, subject to the IRA minimum distribution rules, and pay income tax only on the amount you withdraw. This IRA must be a special account intended only for the rollover of your 401(k). Do not put your 401(k) money into your existing IRA account.

This distribution option is the most flexible because you can invest your IRA however you wish and still have your money tax-deferred.

Do I have to withdraw all of my 401(k) savings when I reach age 70½?
When you reach age 70½, you're required to withdraw a minimum amount depending on your life expectancy. An actuarial table showing life expectancies is available from the
Internal Revenue Service (IRS). You must begin receiving these payments by April 1 of the calendar year following the year you turn 70½.

To determine your required minimum distribution, divide your 401(k) account balance by the number of years remaining in your life or by the remaining joint life expectancy of you and your spouse. Try the calculation both ways. You may find it more advantageous to determine your mandatory withdrawal amount by using both life expectancies instead of yours alone.

You may have to recalculate this mandatory distribution amount each year because of your account balance and life expectancy.

You must pay income tax on each of these mandatory distributions. You cannot roll the distributions into an IRA.
     If your employer
     matches your
     it can be
     for you to

What is the penalty if I do not withdraw funds at age 70½?
If you do not withdraw the mandatory minimum amount beginning at age 70½, your 401(k) may lose its tax benefits and you will have to pay a 50% tax penalty on the required distribution.

Is it possible to continue to participate in my 401(k) program after I'm 70½?
After age 70½, if you're still working for your employer sponsoring the plan, you are eligible to participate. You may continue to participate even though you're subject to mandatory minimum withdrawals.

Is it wise to continue contributing after I reach 70½?
If your employer matches your contributions, it can be worthwhile for you to continue participation.

How long must I wait to receive my 401(k) money after I retire?
Legally, sponsors of your 401(k) plan must give you the money in your 401(k) account within 60 days of the end of the plan year in which you leave your employer after you reach retirement age.

The administrator must value your account before distribution can take place. As a rule, it takes six to eight weeks for valuation and approximately two weeks to pay the benefit.

These IRS publications might be helpful as you decide what to do about your 401(k) distributions when you retire:

©1999 Credit Union National Association Inc.