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Don't Roll Over For This Payout Ploy

Personal Business: Tax Tips


Although the rules about payouts when you leave your company are complex, there has been one simple way to shelter lump sums from tax: Roll over the check from the company's pension fund or 401(k) savings plan into an individual retirement account or another eligible plan within 60 days. But after this year, once you receive that check, it will be too late to avoid a stiff new tax bite.

So, you must arrange in advance for your employer to make a trustee-to-trustee transfer to a cooperating bank, brokerage house, or new employer's plan. Otherwise, lump sums will be subject to a 20% withholding rate.

A major concern of tax advisers is "people being unpleasantly surprised," says Bill Fleming in the Hartford office of accountants Coopers & Lybrand. Those who suddenly change jobs or fall victim to cutbacks are the most likely to "get punished" for not knowing the tax rules.

Without a trustee transfer, a $100,000 nest egg would mean a check for only $80,000. You still have 60 days to roll it into an IRA, tax-free until withdrawal. But to shelter the full $100,000, you'd have to come up with $20,000 from somewhere else.

If you don't make up the difference within 60 days, the $20,000 will also be subject to regular tax even though you never saw it. And unless you're 59 1/2, you'll face a 10% penalty. Whether you ever get the $20,000 back depends on your total tax bill for the year. For instance, you might be overwithheld in general and get back your $20,000 as part of a refund. Or you could even end up owing more.

TAX TRAP. The congressional rationale is to foster trustee-to-trustee transfers so people will keep lump sums locked away for retirement rather than spend the money once they have a check in hand. But few employers now are set up to handle such transfers, so Congress is "leading you down the path" to having part of the nest egg taxed away, Fleming says.

By making withholding mandatory instead of optional, as it is now, "they actually set out to trap people," says Alan Prigal, a New York tax attorney and consultant to Bender's Federal Tax Week. The change is slated to raise $2.1 billion to help pay for extended unemployment benefits in the first year and nearly nothing after that--when most people presumably will have learned from those who got burned.Dick Janssen EDITED BY AMY DUNKIN

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