Retirement Distribution Options

August 23, 2010

I was wondering why he would want to take a 50% lump sum distribution on his pension and take the rest as income when he was only 54 (going to retire at 55) and had a lump sum already – a fairly large balance in his 401(k).  Normally when I counsel people who have a substantial 401(k) balance, they want to take full advantage of the pension distribution – guaranteed for life with a steady stream of payments every single month that gets deposited directly into a bank account.  What could be sweeter and why wouldn’t he want that?  A pension is like the goose that laid the golden egg.

This gentleman’s pension would be paying him an equivalent of 6 1/2 % which is hard to beat in a guaranteed account especially in today’s low interest rate environment.  He needed some funds in a lump sum to put down to build a property in his native South America where he was retiring – his dream was to build a home on the beach.

I wondered why he would invade his pension income and not take the funds from the 401(k) and that is what I asked him.  He was under the impression that the 401(k) funds were tied up until 59 ½ unless he took out substantially equal payments from the account over his life expectancy (for a minimum of 5 years).  “Where did you hear that?” I asked him.  The answer he gave is one I have heard a million times, “A friend of mine told me.”  Well guess what, your friend has it wrong.

There are exceptions to the early withdrawal penalty for employees retiring from a company at age 55 and withdraw their 401(K).  What the friend was talking about was an Individual Retirement Account (IRA) or a 401(k) from a former employer – not his 401(k) from his current employer.  He was talking about different accounts that have different rules.  Here is the link to the IRS tax facts on the subject, http://www.irs.gov/retirement/participant/article/0,,id=211440,00.html

The best way to make financial decisions is to go to a trusted source even though you may like your friend, he may not know what he is talking about.  Your employer’s financial education department is a trusted source and the IRS is another.

I remember when my oldest son was in college; his friend from the dorm told him that he could drop his class well into the end of the semester.  Well he tried to do that and guess what he found out?  His friend was wrong and my son enjoyed a D and had to retake that class.  All he had to do was look it up online on the school’s site or go to the registration department on his way to class one day and ask.  He learned that lesson the hard way.

Well my Ask a Planner participant was going to essentially do the same thing – listen to heresy instead of going to the source.  When I let him know that he could take the distribution from the 401(k) when he retired which allowed him to take the full pension, he was very pleased.  Now he has a new best friend (well other than me) — The Internal Revenue Service.  Who knew that the IRS would be so popular?  Lesson learned – check the important details and go to the source.