Tax Alternatives to the IRA Rollover

In the previous sections of this chapter, we talked about the benefits of rolling over your retirement account distributions to an IRA. While doing this will allow you to avoid the tax man for a while longer, you may be interested in exploring the other options that force you to pay the IRS piper up front, but could be better suited to your situation. These options include ten-year averaging, the twenty percent capital gains tax election, and ordinary income tax.

Let’s look at a case study to explore the thought process that goes into deciding which distribution method is best in a given situation. I want to stress how important it is to think through these options and get counsel before making your election. You only have once chance to make these elections, and the implications are significant. I have people coming into my office all the time with a retirement mess, and I ask them why they made the choices they did. Most of the time, I find they just followed what someone else had done who’d retired before them. Yet the circumstances of each retiree are unique. You want to make the right choice for you, and that choice may be something completely different than what a coworker did.

Case Study: Jonas Beiler, former military officer and retiree

Jonas Beiler (fictitious name) had several careers during his working lifetime and was preparing to retire from a company he’d worked with for the past ten years. Jonas retired earlier from the military and was already receiving a pension from the Navy. He’d accumulated $300,000 in his 401(k) and wanted to take it as a lump sum and use the proceeds to pay off the mortgage on a property in Florida that he bought a few years earlier. He and his wife Sarah planned to split their time between Pennsylvania and Florida during their retirement. The Beilers came to me for help with figuring out how to meet these goals.

We determined between Jonas’ Navy pension, Social Security, and the couple’s other savings, they wouldn’t need this $300,000 to meet future income needs. Jonas was born before January 1, 1936, so he qualified for ten-year averaging. The money had all been put into the account in the last ten years, so none of it was eligible for capital gains treatment. Jonas could take the money out as a lump sum and pay ordinary income tax on the distribution, or he could apply ten-year averaging. Let’s look at the difference between the two options:

  • Ordinary income tax: $100,770
  • Ten-year averaging: $64,475

The other option was to try to spread the distribution over more than one tax year. That would disqualify the distribution for ten-year averaging treatment. The tax under ten-year averaging treatment was so favorable it made for an easy decision.

Read from Chapter Two – Case Study: Bob and Carolyn Whitehall, retirees