Pension plan lump sum distribution / 20 perc tax

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linguista57
Posts: 36
Joined: Fri Mar 17, 2017 8:25 pm

Pension plan lump sum distribution / 20 perc tax

Post by linguista57 »

Hello everybody.

Thank you for reading me and responding.

My boyfriend who is 65 year old is gong to be getting a lump sum (about 50K) from MPI. He is being told that 20 percent will be deducted. I assume this a a federal tax.

questions
If he rolls this into an IRA/ money market. will he be taxed?

If he is not taxed by rolling into an IRA, will he be taxed every time he withdraw money. even if the sum are small given the fact that he is considered below poverty

Thank you all.
Gill
Posts: 6684
Joined: Sun Mar 04, 2007 8:38 pm
Location: Florida

Re: Pension plan lump sum distribution / 20 perc tax

Post by Gill »

Is this from a qualified plan? If so, you can roll it into an IRA. Keep in mind, the 20% withholding is not the tax. His tax may be much less.

Gill
Cost basis is redundant. One has a basis in an investment | One advises and gives advice | One should follow the principle of investing one's principal
Beehave
Posts: 807
Joined: Mon Jun 19, 2017 12:46 pm

Re: Pension plan lump sum distribution / 20 perc tax

Post by Beehave »

If he takes a lump distribution outside of an IRA, it will be immediate income that is subject to withholding and any taxes. If he rolls it into an IRA he will not be taxed until money is withdrawn and can choose how much (if any) to withdraw each year. That way I believe he can control the amount of taxes to be paid much better than can be done with a lump sum.

Since you mention that this person is below the poverty line, they probably qualify for and may be receiving some benefits. I've seen some conflicting information on the web about whether IRA savings and eligibility for programs like food stamps. It seems as if the money in an IRA does not count for SNAP benefits based on this:

https://www.cbpp.org/research/food-assi ... d-benefits.

So parking the money in an IRA might make sense with respect to both taxes and benefits. I hope someone wih deeper expertise than me will chime in on this.

Be aware: there are time limits for getting the money into an IRA that you want to watch out for. You can avoid ththis issue by having the lump sum directly transferred from the employer to the company you choose for the IRA.

You appear to be very concerned for your friend's welfare and I would encourage you to make sure that this $50,000 is put to good use. Specifically, the $50,000 should not be spent quickly simply to be rid of it in order to keep qualifying for any benefits. It should be very carefully budgeted and used, with some set aside for emergency. Many people in poverty develop a network of friends in similar circumstances for mutual assistance and protection, and their needs could quickly use up the money if your friend decides to spread the money around. Your friend must think very carefully about how to use this money for his long-term benefit.

If you are concerned this person may blow the money quickly and have nothing much to show for it, it might be good to turn the lump sum into a monthly income. There are two ways this person can obtain a simple monthly annuity payout. One is to take the $50K as a lump sum, pay any taxes, and invest the remainder in an SPIA annuity (single premium immediate annuity). What seems to me to be the better way would be instead to roll the money into an IRA and pay no taxes and then purchase a QLAC which is an annuity from within the IRA that provides monthly income. Any or all of the $50k can be invested in the QLAC. The monthly income will depend on your friend's age and the amount invested, but it might provide enough income to be really helpful without going over poverty limits and without any or much tax to pay and improve this person's life. You can look at the immediateannuities.com website for further information.

If the decision is to start an IRA but with no annuity-type QLAC, I'd suggest using Vanguard for the IRA. However, I just looked and it seems Vanguard is no longer offering QLACs, so if this person wants a QLAC I have no recommendation as to where to park the money into an IRA that will offer a QLAC option.

Again, I hope others with expertise and ideas will chime in on this.

Best wishes.
Gill
Posts: 6684
Joined: Sun Mar 04, 2007 8:38 pm
Location: Florida

Re: Pension plan lump sum distribution / 20 perc tax

Post by Gill »

Beehive, a QLAC isn’t necessary. An ordinary SPIA can be purchased with IRA funds.
Gill
Cost basis is redundant. One has a basis in an investment | One advises and gives advice | One should follow the principle of investing one's principal
Beehave
Posts: 807
Joined: Mon Jun 19, 2017 12:46 pm

Re: Pension plan lump sum distribution / 20 perc tax

Post by Beehave »

Gill wrote: Fri Oct 16, 2020 6:38 pm Beehive, a QLAC isn’t necessary. An ordinary SPIA can be purchased with IRA funds.
Gill
Gill,
You bring up two important points.
(1) While you can buy an annuity that is not a QLAC within an IRA, there are, as I understand it tax and RMD implications that complicate things. The QLAC simplifies this - - you subtract the QLAC payment from your reported IRA balance (which makes for lower RMDs), and then when the QLAC kicks in the payments are subject to regular taxation. So QLACs were designed to provide what can be advantages over ordinary (non-QLAC-designated) SPIAs.

(2) Your post made me realize that there are QLAC limits based on the lower of a $135,000 purchase or 25% of your aggregated IRA balances. SO... it may well be the case that someone "in poverty" with a $50K lump-sum windfall invested into an IRA may only (unless there are more resources in an IRA) be able to invest $12,500 into a QLAC, which might not be enough to be a worthwhile investment.

Thanks for your fact-checking - it is helpful!
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