Rollovers must be done right to avoid penalties

Troy Kennedy is a senior vice president and shareholder with Springfield Trust Company, a trust and investment company.

You've spent the last 40-plus years waking up at a certain time and spending most of your waking hours working to provide income for the family.

It can be a shock to the system to suddenly be voluntarily unemployed aka retired. There is a withdrawal process for retirees because they're not on a set schedule like they were during their working career.

If you are thinking about retiring, consider how to spend your retirement. It might be appropriate to slow down by working part-time or volunteering for a nonprofit agency.

But before retirement, there are some terms to become familiar with.

Transfers: Transfers occur within IRAs when moving assets from one financial institution to another.

There is no limit to the number of transfers during a year.

Rollovers: Rollovers occur when the funds are paid directly to the participant. Upon receipt of the funds, participants have 60 days to "roll" them over to an IRA. This transaction is only allowed once every 12 months.

Failing to roll these funds within the 60-day time period results in full taxation of the assets. In addition, a 10 percent penalty will be applied if the participant is under 59 1/2 years old.

Direct rollover: A direct rollover occurs when funds are transferred from a qualified retirement plan (profit sharing, 401(k), etc.) or tax-sheltered annuity directly to an IRA.

However, if a plan is being terminated, or the participant has separated from employment and elects to receive the assets directly, the plan trustee is required to withhold 20 percent to be applied toward the tax owed.

For example, a participant is retiring and elects to receive the assets from the retirement plan directly until deciding where to establish an IRA. The balance of the account is $500,000. The trustee of the plan is required by law to withhold $100,000 (20 percent). Therefore, the participant will receive $400,000. The participant then has 60 days to deposit the full $500,000 into an IRA. Amounts not deposited are subject to full taxation and any applicable penalties. This means the participant will have to come up with the $100,000 difference from other sources.

One way to avoid this is a trustee-to-trustee direct transfer.

Minimum distribution rules

Some other planning considerations during retirement are the minimum distribution requirements at age 70 1/2.

Under the former rules, the required minimum distribution from an IRA or retirement plan 401(k), profit-sharing plan, 403(b) tax-sheltered annuity) was calculated using a method chosen by the account owner from among several complex formulas.

The amount of the required minimum distribution depended upon the life expectancy of the account owner and, in most cases, the account beneficiary. The required minimum distribution could vary significantly depending upon the formula used and who was named as primary beneficiary.

The new rules generally provide that the lifetime required minimum distribution be recalculated each year based upon a uniform table. The account balance at the end of the preceding year is divided by the applicable age-based factor found in the table.

The table is used whether or not the account's designated beneficiary is the account owner's spouse, and with one exception, regardless of the age difference between the account owner and the beneficiary. Therefore, all an account owner usually needs to determine the required minimum distribution is his or her current age and the account balance at the end of the prior year.

In many cases, the use of the uniform table will result in a lower required minimum distribution under these new rules.

An example: John Doe turned 70 l/2 in the year 2002 and plans to begin taking his required minimum distribution in 2002. His Dec. 31, 2001, IRA balance was $500,000. Under the new rules, his required minimum distribution will be $19,083.97.

The new rules have made it easier for taxpayers to lower the amount that is required to be taken out of retirement plans once the owner reaches age 70 1/2.

Beneficiary designations

Upon establishing your IRA, you must select a beneficiary who will receive the funds at your death. If none is selected, the assets will go through probate, and Missouri law provides for the disposition of these assets. (Probate is a time-consuming and costly process, and one that I strongly urge you to avoid.) The most common beneficiary is your spouse.

Careful consideration is necessary, and the advice of your estate planning attorney and/or CPA is critica1 to avoid adverse income- and estate-tax consequences.