By: P.J. Medina


When it comes time to collect your company pension benefits, you’ll be faced with a number of options and bewildering array of tax consequences. Avoid costly mistakes by learning the tax rules now, well before you’re eligible for a payout from your company’s plan.

Payout Possibilities

Most plans let you take your benefits either as an annuity or in a lump sum.

The annuity is usually a fixed monthly amount paid out for the remainder of your life. Many plans, however, allow joint and survivor annuities. These pay lower monthly amounts but continue as long as you or your spouse is alive.

Estimate the value in today’s dollars of the total annuity payments you could expect to receive. Compare that figure with the value of the lump sum you’re eligible for. Factors to consider: The state of your health. An estimate of potential investment returns if you choose to take the lump sum and invest it yourself. Required: The help of a tax adviser who has expertise in retirement planning and access to computer programs to analyze the options. Then, compare the tax consequences of each payout option.

Lump-Sum Tax Breaks

When they are received, lump-sum distributions may be taxed under special tax-saving rules if certain conditions are met. Or you may defer tax on the distribution by rolling it over (transferring it) into another tax-sheltered retirement plan. Special rules for lump sums for taxpayers who were age 50 before January 1, 1986:

Capital gains treatments: The part of a lump-sum distribution attributable to your participation in the plan before 1974 is eligible for capital gains treatment.

Ten-year averaging: The non-capital-gains portion of the distribution is taxed under a special method called 10-year averaging. That taxes the distribution at a relatively low rate.

If you choose, you can elect 5-year forward averaging on the whole distribution.

Five-year averaging: If you were not age 50 by January 1, 1986, you will be eligible for five-year forward averaging once you reach age 59 1/2 . You may also be eligible for capital gain treatment on some of the distribution.

Conditions for Lump-Sum Tax Treatment

For a retirement plan payout to be treated under the favorable lump-sum tax rules, the following conditions must be met:

*You must receive everything you have in the plan during a single tax year. If your company covered you under more than one plan of the same type (pension or profit-sharing), your accounts in each plan must be received in the same year.

*You must have been in the plan at least five years before the year of the distribution.

*At the time of the payout, you must be totally disabled, separated from service with your company or older than 59 1/2.

Tax-Free Rollovers

A lump-sum payout is not subject to tax, if within 60 days you roll it over into another qualified retirement plan-a company plan, a Keogh Plan, or an IRA.

Problem: A rollover into an IRA may cost you eligibility for lump-sum tax breaks (unless you refrain from putting any other funds into the rollover account and eventually roll it over again into a Keogh Plan or company retirement plan). Rollovers directly into a corporate plan or Keogh Plan avoid this problem.

Suggestion: As you near retirement, look for a way to earn some self-employment income. Set up a Keogh Plan, and roll your company lump-sum distribution into the Keogh Plan.

Tax Pitfalls and Penalties

*If total distributions from retirement plans, IRAs, etc., exceed $150,000 within one year, the excess is subject to a 15% excise tax.

*A 10% penalty tax is imposed on distributions made before the account owner reaches age 59 1/2, becomes disabled or dies. The tax is waived for any part of the distribution that is made as an annuity, or made to cover deductible medical expenses, or made to an employee who is age 55 or older and has separated from service and has satisfied his company’s plan requirements for early retirement.

Source: Peter Elinsky, partner, and Deborah Walker, partner, KPMG Peat Marwick, 2001 M St., Washington, DC 20036.


The primary rule: Any money taken out before you reach age 59 1/2 is subject to a 10% penalty tax. For that reason, it’s best to take out only as much as you have to. Any large distribution can put you in a high tax bracket and you lose the benefit of tax-free earnings whenever money is taken out of the fund.

Keogh Plan distributions may qualify either for five-year averaging, or, if you were age 50 before January 1, 1986, for the 10-year-averaging method applicable to lump-sum pension distributions. This method does result in large savings.

Distributions after a taxpayer’s death are also taxable, and there may be an estate tax.

When Is a Distribution Required?

You must begin to distribute your account no later than April 1 of the calendar year following the year in which you reach age 70 1/2.

You can withdraw the whole account in a lump sum, but you don’t have to. You must, however, make a minimal withdrawal each year, calculated on the basis of your life expectancy at that time (or that of you and your beneficiary). For example, if your life expectancy (or that of your beneficiary) is 14 years, you would have to withdraw 1/14 of your account that year. If your life expectancy was 12.2 years, you would have to withdraw 1/12.2 of your account, and so forth. The IRS publishes life expectancy tables to use in the calculation.

If you withdraw less than you should, there’s a 50% penalty on the difference. Example: You withdraw only $2,000 in a year when the minimum required is $8,000. You can be penalized $3,000 (50% of the $6,000 difference).

Two Loopholes

You do, however, get a tax break. The minimum requirement is figured as of the first of the year, but you don’t have to take it out until December 31. The account’s earnings for the year are tax free and remain in the account.

Example: The account is $100,000, invested at 8%. In a particular year, you’re required to withdraw 1/10. By December 3l, the account will have grown to $108,000, but you have to take out only $10,000.

Source: Louis Wald, vice president, tax advisory department, Merrill Lynch,
Pierce, Fenner & Smith, 25 Broadway, New York 10004.


The 10% penalty tax on pre-age-59 1/2 withdrawals from IRAs does not apply if the money is taken out in the form of an annuity, that is, in a series of payments over one’s life expectancy or the joint life expectancies of a couple. This loophole can be put to good use if there is a fair amount of money in your IRA, say $100,000, from the rollover of a company pension plan.

Opportunity: Take out a $100,000 home-equity loan, and use it for any purpose. (Interest on up to $100,000 of home-equity borrowing is fully tax-deductible regardless of what the money is used for.) Use the annuity payments from the IRA to make your mortgage payments. The annuity payments are taxable income, but the interest portion of your mortgage is tax-deductible. So, the annuity payments, in effect, are tax-sheltered by the mortgage deductions.

Variation: If planning to start a business, borrow from a bank. Your interest payments would be fully tax-deductible business interest. Use your annuity payments from the IRA to pay off the bank.

Source: Edward Mendlowitz, partner, Mendlowitz Weitsen, CPAs. Two Pennsylvania Plaza, New York 10121. Mr. Mendlowitz is the author of several books, including New Tax Traps/New Opportunities, Boardroom Classics, Springfield, NJ 07041.


Borrow from an IRA legally by making a short-term loan. Generally, IRA borrowings are prohibited. But it is possible to move funds from one IRA to another, so long as the transfer is completed in a 60-day period. Benefit: You have use of the funds for 59 days. Warning: The exact amount you take out of the first IRA must be placed in the second one within the 60 days. And you can use this device only once in a 12-month period.


You have to start your IRA withdrawals no later than April 1 of the calendar year following the year in which you reach age 70 1/2 . The minimum withdrawal depends on your life expectancy or the combined life expectancy of you and your beneficiary. (The IRS has actuarial tables that determine the life expectancy you must figure on.) However, you might be able to put more funds into the IRA at the same time you make your withdrawals. Example: A retiring executive expects to receive a lump-sum distribution from his firm’s profit-sharing plan when he reaches age 72 or
73. He asked the IRS if he could roll it over into an IRA. IRS response: Yes. He can put the full amount in (and thereby defer taxes on it). But he must immediately take part of it back out.

Source: Revenue Ruling 85-153.


Savings bonds provide an excellent tax-sheltered way of saving for a child’s education or your own retirement. Key: The investment return earned on savings bonds has been increased and pegged to market rates.

Shelter Aspects

Series EE savings bonds appreciate in value instead of yielding interest. The return on EE bonds is factored either at a periodically adjusted guaranteed annual rate, or at 85% of the rate paid on five-year Treasury securities, whichever is greater. Tax-shelter benefit: You get to choose how to have this appreciation taxed. Options:

*Have the gain taxed each year, as you earn it.

*Defer tax until a year when you are in a lower tax bracket, then elect to have all the appreciation earned to date taxed at once.

*Defer tax on the appreciation until the bond matures.

*Defer tax indefinitely with a tax-free conversion of matured Series EE bonds into Series HH bonds, which pay 6% cash interest. This interest is taxable, but the conversion lets you avoid the tax on the EE bond appreciation until the HH bonds mature. And the Treasury customarily renews maturing bonds, so this may be many years in the future.

Savings Strategies

Buy savings bonds for a child who will go to college some years from now.

Savings bonds come with a built-in tax benefit that provides a way around the new kiddie tax. Tax on the accrued interest is not due until the bonds are cashed in at maturity. Loophole: The kiddie tax, which taxes the investment income of a child at the parent’s tax rate, applies only for the period in which a child is under age 14. So, if you give a very young child savings bonds that don’t mature until the child is 14 or older, the interest will be taxed at the child’s rate, not yours. The tax savings subsidize education expenses.

Buy bonds for yourself as a supplement to your normal retirement program. Elect to defer tax on the bonds, then convert them to HH bonds when they mature. Result: You get 6% cash interest on the appreciated value of the bonds, without having to pay on the appreciation until you cash them in.


Once upon a time, long-term capital gains were favored under the tax law, and, once upon a time, you could claim a deduction for your contributions to your individual retirement account (IRA), and let it garner income without the imposition of current taxation. Your level of income didn’t matter, and it didn’t matter if you were covered by any other retirement plan, Now, if you are in another retirement plan and your income is too high, you may not get a deduction for your IRA contribution.

The old rules were great, but this is now, and now you should not discount the value of your old IRA, especially with regard to its investments.

When capital gains were taxed at much lower rates than ordinary income, it was not advisable to produce long-term gains in your tax-sheltered retirement account. The benefit was wasted. The thing to do then was to invest the IRA for lots of ordinary untaxed current income.

Now that all income, long-term gain or not, is taxed at roughly the same rate, you should consider investing in assets that can produce big gains as well as assets that yield current dividends or interest.

You may continue to make a contribution to an individual retirement account each year within the familiar $2,000 limits (expanded to a total of $2,250 if a spousal IRA is included), but your contribution will be deductible only if: (a) you (include your spouse if you file jointly) are not an active participant at any time during the tax year in a retirement plan maintained by an employer, or (b) if your income is below a certain level. The level depends on your status. If your adjusted gross income is between $40,000 and $50,000 and you’re an active participant in a plan, the
deductible part of your contribution is phased out on a joint return. On individual returns, the deduction phases out on income between $25,000 and $35,000. For married couples filing separately, the phaseout starts at zero and is completed at $10,000.

As under prior law, once a tax year begins, a contribution to an IRA may be made at any time before the due date of that year’s return. Don’t wait until the last minute; the sooner you fund your IRA, the more growth there will be.

Regardless of whether your contribution to your individual retirement account will be deductible, its earnings will not be subject to tax until they are withdrawn. Now is the time to consider setting aside $2,000 to grow tax free, and that investment might, if you like, be in an asset that will increase in value over the long term and produce capital gains.

Under prior law, IRAs were not permitted to invest in collectibles or precious metals. That rule has been relaxed, and now your IRA can hold silver or gold coins issued by the United States. No jewelry, though – you can’t wear your IRA.

Source: New Tax Loopholes for Investors, by Robert Garber, Boardroom Classics, Springfield, NJ 07041.


Making your wife a partner in your business could boost her ultimate Social Security retirement benefits. As a partner, the wife now has self-employment income. When she reaches retirement, her benefits will be based on that income. This could far exceed the percentage of her husband’s retirement benefits that she would get if she had no earnings of her own on which to compute her Social Security entitlement.

Source: Dr. Robert S. Holzman, professor emeritus of taxation at New York University and author of Encyclopedia of Estate Planning, Boardroom Books, Springfield, NJ 07081.

401(k) PLANS

Cash or deferred profit-sharing plans, technically called 401(k) plans, offer retirement-minded employees much bigger tax benefits than Individual Retirement Accounts (IRAs). Key to the potential tax windfall: A cut in pay. These plans also provide tax savings for the employer.

How they work: The company sets up a qualified profit-sharing plan, or conforms its present plan to the tax law’s 401(k) requirements. The plan permits employees to defer taking a portion of their salary – let’s say 5%. The deferred salary is contributed directly into the plan by the company.

As with an IRA, the employee pays no tax on the contribution. And the income earned builds up tax-free in the plan.

Compared to an IRA, a deferred-salary program offers significant tax advantages to the employee:

*The annual limit on contributions is now $8,475 (indexed for inflation), as opposed to $2,000 with an IRA ($2,250 for spousal IRAs).

*Unlike IRA distributions, retirement distributions from a deferred-salary plan may qualify for five- or ten-year-forward income tax averaging. This can result in substantial savings.


A provision in ERISA (the 1974 pension law) makes it possible for a small, closely held corporation to provide its older insiders, in a relatively short time, with pension benefits substantially larger than their compensation – and with the cost fully deductible by the corporation.

Example: A Mr. Smith, having elected early retirement from a major corporation, starts up his own consulting corporation. He brings his wife into the business as an assistant and has two part-time employees to help her with various chores. He puts his wife on the books for $6,000 a year, although she’s worth more. Even though he considers increasing her pay, he has prudent misgivings, because her earnings will only add to the taxable income on their joint return.

Taking advantage of ERISA, Smith sets up a defined-benefit pension plan (where benefit payout is fixed) for his corporation. Under the so-called deminimis provision of ERISA, he can set his wife’s defined benefit upon retirement at $10,000 a year – $4,000 more than her annual salary. She’s able to escape the benefit limit of 100% of her annual salary because her salary is under $100,000.

To establish the $10,000 benefit, he must show actually what it would cost to provide her with a straight-life annuity of $10,000 a year at age 65. That’s easy. All he has to do is ask a life insurance company how much such a policy could cost, Answer: $140,000 lump sum. Thus, if you figure an 8% annual interest, compounded, it works out that he must put away $10,000 a year for the 10 years – or a total of $100,000.


The Social Security Administration (SSA) operates a toll-free hotline* to answer questions and solve problems. What people ask:

1. My circumstances have changed… how do I change my records?

All changes can be entered immediately into the SSA computer over the Hotline. What to report:

*New address.

*Death of a close relative (parent, spouse, etc,) who was receiving Social Security benefits.

*Name change (for instance, when a woman marries and changes her last name). If you don’t notify the SSA, Social Security taxes that you pay may not be credited to your account.

*Return to work if you were receiving disability benefits.

2. How much will be deducted from my Social Security benefits for Medicare?

If you elect Medicare Part B Supplementary Medical Insurance, which helps pay doctor bills, the premium is deducted from your Social Security check. Medicare is available to retirees at age 65 and to disability beneficiaries after two years on disability. Cost: $28.60/month.

3. I lost my Social Security card… what should I do?

File form SS-5, which you can get by calling the Hotline or from any SSA office. The replacement process is much faster if you know your number.
Cost: Free.

Although you don’t need a card to receive Social Security benefits, some employers require that you have one.

4. I didn’t receive my Social Security check… what happened?

Most checks that disappear are either lost in the mail or stolen from the person’s mailbox. To prevent these problems, we recommend that recipients have their checks deposited directly into a bank account. Call the Social Security Administration to initiate direct deposit… have your bank account number available.

5. What do I have to do to start receiving Social Security benefits when I become eligible?

The government does not automatically start sending Social Security checks once you are eligible. You must file the appropriate application form, which is available at your local Social Security office or by calling the toll-free number.

6. How can I get a Social Security number for my child?

You can’t do this over the phone… but a Hotline representative can send you the form (SS-5), which must be completed and returned with the proper documents (generally a birth certificate and one other form of identification – an insurance policy, medical record or passport).

Even easier: A service called Enumeration at Birth now lets parents of a newborn get a Social Security number for their child through the hospital (ask a hospital representative for more information). This service is now available in 37 states.

It’s best to apply for a Social Security number when children are born – it is needed to open a bank account for them… to give them Savings Bonds… and to claim children age two or over as dependents on your tax return.

*800-234-5772. Hours: 7 am to 7 pm in all time zones, Monday through Friday. All other times, a recording provides general information, an answering machine will take your name and number and a representative will call you back.


The 10% penalty on withdrawals and payouts before age 59 1/2 , which always applied to IRAs, has now been extended to all qualified plans, including company pension and 401(k) plans. However, there are some important exceptions…

The following payments are not subject to the 10% early retirement penalty:

*Distributions made because of death or disability,

*Distributions to employees age 55 or over under a company’s early-retirement system.

*Distributions in the form of annuities – substantially equal periodic payments (at least once a year) over your lifetime or life expectancy. Caution: Once you elect the annuity form of payment, you can’t switch to another form until five years have elapsed or until you reach age 59 1/2 , whichever is later.

*Distributions pursuant to a court order on domestic relations, such as divorce, separation, or child support.

*Distributions to pay medical expenses, up to the amount allowable as a medical deduction on your income tax. Caution: This exception is not allowable for IRAs.

*Certain distributions by ESOPs (Employee Stock Ownership Plans), IRA owners have always been required to make annual withdrawals from their accounts, starting April 1 of the year following the year they reach age 70 1/2. Beginning in 1989, the rules will apply to participants in any qualified retirement plan. (They already apply to those owning 5% or more of the business.)

The minimum distribution required each year will depend on your life expectancy or the combined life expectancy of you and your beneficiary. The penalty for noncompliance is severe – 50% of any amount that should have been paid out but was not. If you’re near age 70 1/2, check with your tax adviser, employer, or plan administrator.

Source: Deborah Walker, partner, KPMG Peat Marwick, 2001 M St., Washington,
DC 20036.


The tax laws are peppered with loopholes designed to help us live comfortably in retirement.

*Tax-free home sales. If either you or your spouse is 55 or older when you sell your house, and you have lived in it for three of the last five years, the first $125,000 of profit is completely tax free… if you wish it to be. This tax break is optional, not mandatory, It can be taken only once, and, if one spouse has taken it previously, it can’t be taken again by a married couple even though the other spouse never used it.

It’s important that you not waste the exclusion, since you lose it once you use it. Do not elect the exclusion if:

…you plan to buy another house. In this situation, you qualify for another tax break-tax deferral. Homesellers can defer tax on their profits by investing them in another house within two years of the sale. Using tax deferral preserves your right to take the $125,000 exclusion on a future sale.

…the profit on the sale of your home is relatively small. If you use the exclusion for a $15,000 gain, neither you nor your spouse may use it again, ever. You may be better off paying the tax on a small gain and saving the exclusion.

Loophole for soon-to-remarry couples: If one spouse-to-be has used the exclusion and the other hasn’t, the spouse who hasn’t used it should sell his or her house prior to the marriage and take the exclusion. It will not be available if the sale occurs after the marriage.

*Gifts to grandchildren. Think twice before selling appreciated assets, such as securities, to provide cash gifts for your children and grandchildren. It may be better to give the assets directly to the kids and let them sell them. A gift of the property will save tax (and create a bigger gift) if the recipient is in a lower tax bracket than you. The recipient will pay less tax on the gain than you would at your high tax bracket.

The giving strategy changes if the recipient intends to retain the property. In this case, it’s better to give cash now and let the intended recipient inherit the appreciated property. Reason: The recipient will inherit the property at a stepped-up basis, that is, its value at the date of your death. He or she won’t have to pay capital gains tax on the property’s increase in value.

*Rent a condominium from your children. A way to get Uncle Sam to subsidize the cost of supporting an elderly parent is for the children to buy the parent’s retirement condominium and rent it to the parent. At the very least, the children will get tax deductions for mortgage interest and property taxes. These deductions will produce a greater tax benefit to high-income children than they would to a low-bracket retired parent. And, if the children charge the parent fair market rent, they will also be able to take depreciation deductions on the condo. The 1986 tax reform allows
you to deduct up to $25,000 of losses if your adjusted gross income is less than $100,000. This loss allowance is phased out between $100,000 and $150,000 of adjusted gross income.

*Plan in advance for nursing home care. Before the government will pay your nursing home bills, you have to use up the money that’s in your name.

Strategy: Put your money into a trust that pays you income but which doesn’t allow you to touch the principal. Then only the income would be lost to nursing home care – you won’t lose the principal.

Caution: In most states, a trust that is set up within two years of a person’s entering a nursing home won’t be effective. Check with an attorney about your state’s laws.

*IRS vs. remarriage. A married couple, both age 65 or over, will pay more tax on a joint return than the combined tax they would pay if they were single. Another consideration: If income (including tax-exempt income) plus one-half Social Security benefits exceeds certain levels, half the Social Security benefits are taxable. The levels are: $25,000 for a single person or $32,000 for a married couple. Combining incomes on a joint return may force taxation of Social Security benefits that would completely escape taxation if the couple did not marry.

*Retirement plan distributions. You must start taking money out of your Individual Retirement Account by April 1 following the year in which you reach age 70 1/2 . Loophole: You may be able to slow the distribution down (take less in the early years) by using actuarial tables. Check with the IRA trustee to see if a slower distribution schedule can be used for your payouts.

*Power of attorney. Many elderly people fail to plan for the possibility that they might become unable to handle money. Suggestion: Give a power of attorney over one bank account to a relative or other trusted person. If you become incapacitated, that money will be available for your care.

*Life insurance. Consider setting up a trust to take out life insurance to pay the estate taxes that will eventually go to the government. Premiums for people in their early sixties are lower than you might think. This can be a low-cost way of paying estate taxes.

Source: Edward Mendlowitz, partner, Mendlowitz Weitsen, CPAs, New York.


The tax law limits deductions for mortgage interest and investment interest. Consumer interest deductions (interest on car loans, credit-card balances, student loans, etc,) are now eliminated altogether.

Mortgage interest is fully deductible on your principal residence and one second residence, but only to the extent the mortgage debt doesn’t exceed:

*$1 million in acquisition debt – used to acquire, construct, or improve a residence, and

*$100,000 in home-equity loans – used for any purpose.

Note: Mortgages taken out before October 14, 1987, aren’t subject to the dollar limits.

Investment interest. Interest on money borrowed for investment purposes remains deductible, but only up to the amount of your net investment income-dividends, interest, etc. (plus 40% of any excess to a maximum of S 4,000 in 1988, 20% to a maximum of $2,000 in 1989, and 10% to a maximum of $1,000 in 1990).

Consumer interest, etc., is no longer deductible. This applies not only to consumer interest (car loans, credit-card purchases, etc.), but also to student loans, interest paid on tax deficiencies – in fact, anything but mortgage and investment interest. Source: Florence B. Donohue, Esq., a New York tax attorney.


Many retirees would like to keep working after retirement, at least part-time. But those who want to work for financial reasons should be aware of these drawbacks:

*You can work and still collect full Social Security benefits, but if you’re between 65 and 69 for every $3 earned above a government-determined ceiling you lose $l in benefits. When you add your commuting costs, job-related expenses, and payroll deductions, you may find part-time work doesn’t pay off.

*If you continue working part-time for the same company, you may not be eligible to collect your pension. One way around this, if the company will go along, is to retire as an employee and return as a consultant or freelancer. Since you’re now self-employed, your pension won’t be affected.

*Although most employees can’t legally be compelled to retire before age 70, companies still set up retirement ages of 65 or under. You can work past that age, but you won’t earn further pension credits. And you lose Social Security and pension benefits while you continue to work.

A very attractive alternative to working part-time is to start your own business. Professionals such as lawyers can often set up a practice, setting their own hours. Or you might turn a hobby into a business.

Source: William W, Parrott, a chartered financial consultant at Merrill Lynch, Pierce, Fenner & Smith, Inc,, 1105 Ave, of the Americas, New York 10036.


An executive retired knowing that he had earned a $20,000 bonus under a company incentive plan, But under the plan’s terms, the bonus wouldn’t be paid until January of the year following his retirement. IRS ruling: The bonus will be treated as earned income in the year the executive receives it, even though he’ll be retired in that year. Thus, the executive can use the bonus to make an IRA contribution for that year, even if he doesn’t work at all during the year.

Source: IRS Letter Ruling 8707051.

(The above material was published by Boardroom Secrets, 1991.)
Christian Information Network