Use ten year averaging to compute tax
401k : It may be that you cannot afford to roll over all of your retirement distribution because you need the money. And if you do need the money, you don’t want to give up a large chunk of the distribution to income taxes. Although there is no way to avoid paying taxes if you elect not to roll over the distribution, you may be able to compute the tax using the method called then year averaging, which can reduce your total bill.

Who is eligible?

You are eligible to use ten year averaging if you satisfy all of the following conditions:

• You were born before 1936
• You have not used ten year averaging on any distribution since 1986
• You participated in the plan for at least five years, which means you or your employer made a contribution to your plan account in the last five separate years before the year of the distribution.

Which distributions are eligible?

Even if you are eligible, you may use ten year averaging only if your distribution also qualifies. Your distribution will qualify only if both of the following are true:

• The distribution to be averaged must be the entire amount of your qualified plan or qualified annuity. You cannot roll over part of the distribution and you cannot have rolled over part of it in the past.
• You must receive the distribution all within one tax year, even if you receive more than one payment.

How is it computed?
If you receive a distribution and elect to use ten year averaging, the tax on the distribution itself is computed on the IRS Form 4972 and recorded on a separate line of your tax return. You must pay that amount to the IRS even if you owe no other income taxes. 401k

The tax is calculated as though you were a single individual and as though you received the distribution in then installments over ten years. Despite this calculation, you pay the total tax due in the year of the distribution not over ten years.

401k - Rather than paying ordinary income tax on your entire retirement plan distribution you might consider a more versatile and attractive strategy: rolling some or all of the distribution into an IRA or another employers plan.

A rollover is usually accomplished by having your employer transfer your funds directly to another employers plan or an IRA Rollover through a transaction called direct rollover. If the funds are distributed directly to you, however, you have 60 days to deposit them into another plan or an IRA. The portion that is rolled over will continue to be tax deferred and will be subject to all the rules of the new plan or IRA Rollover. Any portion that is not rolled over with 60 days will be subject to ordinary income tax. 401k

(tip) rollovers into another qualified plan after retirement are unusual. This is because once a person retires, he or she probably doesn’t have another plan. Distributions at retirement are usually rolled into an IRA, unless you are taking your benefints as an annuity, in which case no rollover of any kind is permitted.

Who is eligible?

Anyone who receives a distribution from a qualified plan or qualified annuity is permitted to roll it over. It doesn’t matter how old you are or how long you have been participant in the plan.

Some people are tempted to choose the path of least resistance. This is true in life generally, but especially true in that part of life that requires dealing with the IRS. When taking distributions from a retirement plan, the easiest option is simply to take the money, deposit it in your regular bank account and report the amount of the distribution as ordinary income on your tax return at tax time.

But if your retirement plan distribution is large, you ordinarily would not choose to pay tax on the entire amount unless you need the money immediately and don’t qualify for any special tax options.
Another reason you might have to use the ordinary income tax option is if you made a procedural error when attempting to use one of the other tax options, which left you no choice but to use the ordinary income tax option.

Who is eligible?

Anyone who receives a distribution from a retirement plan can choose to have the distribution taxed in this way.

Which distributions are eligible?

All distributions you receive from a retirement plan that are attributable to pretax contributions or to investment returns may be taxed at ordinary income tax rates. This is true whether the distribution represents only part of your account of the entire balance.

Advantages and disadvantages

The advantage of this tax option is that once the money comes out of the retirement plan and you pay the taxes owed, you have unrestricted use of the funds. The money that you withdraw is no longer subject to the term of the plan.

But that peace of mind is expensive. Paying tax at ordinary rates on the money in the same year you receive it is usually the least advantageous option – at least from a financial perspective. If your distribution is large, it could easily push you into a higher tax bracket. Its hardly cheery to think of starting your retirement by handing the government 40% or more of your nest egg.

401k: In general, when you receive a distribution from a qualified plan or qualified annuity, you should consider three tax options:

• ordinary income: You can report the distribution on your return as ordinary income
• Rollover : the distribution into a Traditional IRA, 401k or another retirement plan, which means you can continue to delay paying taxes.
• Ten year averaging : If you qualify, you can use ten-year averaging, which is a method of computing the tax through the distribution were spread over a ten year period.

(caution) after tax contributions aren’t taxable. If part of your distribution includes after tax contributions you made to your plan, those amounts will not be taxable and should not be included when computing your income tax using any of the above methods.

(tip) conversion to Roth IRA. Beginning in 2008, you will be able to roll over or convert your qualified plan assets to a Roth IRA, if you meet eligibility requirements.

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