The simplest way of reporting the money distribution of retirement money is to claim the money, deposit in the bank account and report it during the tax filing time. Here you have to pay tax on entire amount and you shall use this only when you are not qualified to any of the exemptions. If you have done any procedural error then you will not be having any choice other than reporting the income under ordinary tax rules. But the disadvantage is you will fall into larger tax bracket and you need to pay higher tax. It may fall into 40% tax bracket and it will be a burden.
Your employer can transfer your money into another retirement account and you need not pay tax for that money. This option could be a IRA. If you receive money directly into your account you will be having sixty days to deposit that money into other retirement plan and you will be getting the tax exemption. The money in your account after this period is taxable as per tax rules. Every individual is eligible into this roll over plans irrespective of age and the duration of the job.
The disadvantage of this rollover of distribution is you can not use all the money for big investments and you need to use the money in small sizes. Another disadvantage is you can not get back the plan once you have committed for a choice like roll over for Roth 401K option. That is you can not change your mind once taken a option and paid money for that.
You can not rollover some portion of money and you shall distribute that money once if you are having a age of seventy and half years. If you have accidentally rolled the extra money you will have time until next tax date to correct it.
Ten year tax averaging is a choice you can choose if you decide to distribute the money that you got over the retirement. You are eligible for this
- If you have born before the year 1936.
- If you have not used this option since 1986.
- Your employer contributed for your plan for at least five years.
You can use ten year averaging only when you use your entire amount that you have in your account and you can not roll over some amount into other plans for tax exemptions.
All the money distribution shall happen in one year to qualify for this plan.
You can not use ten years tax averaging plan if you have opted different retirement plans and you going to receive benefits in different years. You are not allowed to rollover money received in one plan and use the second plan output for tax average option.
Here you have to pay the tax as if you have received the money over ten year’s period and need to pay the entire tax in the same year.
How to calculate ten years tax averaging step by step process:
- First you have to calculate the amount that is taxable. Your employer will give you this information and you need to consider the entire amount that you received for this.
- You shall calculate minimum distribution allowance (MDA). If your distribution is less than $70000, you can exclude some amount as MDA. A) To measure this MDA first we shall reduce taxable amount by $20000 and it shall not be reduced to zero. B) Multiply the result with 20% or with 0.2. C) Subtract the result from $10000 or from one half of the total taxable money which ever is less. The output of this calculation is called MDA.
- Subtract your minimum distribution allowance from taxable amount that is step two is subtracted from step one.
- Divide the result of step three with 10.
- You shall compute the income tax for all the money that you got in step four. For this you shall use income tax rules of 1986 for a individual.
- Multiply the result with 10 and that is the tax that you have to pay.
The advantage is you need to pay less tax when compared with regular income tax bracket. But the problem is tax rates of this plan are high and you are going to pay significant amount of your money as tax. It may be less than regular income tax but it is not a good idea to choose this when compared with roll over options. This choice has to be exercised only when you need to use the money available for you.
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