If you have a substantial amount of money in your company’s retirement plan, one of the more dreaded taxes you may face is the 15% excise tax. The 15% tax is generally imposed on those receiving annual or lump-sum distributions in excess of the following amounts:
- an annual distribution in excess of $150,000
- a lump-sum distribution in excess of $750,000
You can receive a distribution of up to $150,000 and a lump-sum distribution of up to $750,000 in the same year, without triggering the excise tax.
If you are subject to the excise tax, there is good news: You don’t have to wait until you retire to begin to offset the tax. Incidentally, there is no way to escape the excise tax if you wait too long. The key is to start withdrawals earlier than age 70½ when mandatory distribution requirements commence.
The law allows withdrawals starting at age 59½ without the 10% early withdrawal penalty–even if you are still employed. Early withdrawals after age 59½ can help keep the account balance under the 15% excise tax cap, even with annual tax-deferred earnings on the remaining balance.
While people approaching retirement often like “access” to assets, those that are still working will have a continuing salary until they retire and may not need any additional current spendable income. However, it may be advantageous to take additional income in order to avoid the potential 15% tax trap. You might consider the following suggestions:
- Start drawing on earnings after age 59½ and use discretionary income generated by such early withdrawals to make annual gifts to family or charities, until retirement.
- If you and your spouse are in good health at age 70½, annuitize your account balance, rather than making required minimum withdrawals of an ever-increasing percentage subject to tax.
The annuity satisfies the minimum withdrawal requirements and substitutes security and simplicity for a problem in years to come. With a lifetime annuity, neither you nor your spouse will ever exhaust the account balance, no matter how long you live.
Because there are many exclusions to the 15% excise tax, check with your accountant to determine if you qualify for one of the exclusions. Early planning can offer the potential of minimizing the government’s share of your retirement benefits.
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