Do I have to be employed to roll over part of my lump sum distribution to a traditional IRA?
I own a small annuity from a former employer. I'm currently being offered a lump sum totaling $26,000. My spouse and I are going to cash out half of the annuity because we owe back taxes and want to pay it off. The problem is I'm still not employed, so I don't know where to put the other half. My spouse works and has his own generous retirement plan from his employer. I do get a small income that's tax exempt from foster care, but I plan to start working again in the near future. We were thinking a traditional IRA for now, but is that even allowed?
The short answer to your question is: Yes, you can roll over a qualified plan from your employer into a traditional IRA.
The other question is, should you? Depending on the type of annuity, it could be a great way to get free from IRS debt- or a terrible retirement strategy if it is a generous pension.
If the $26,000 being offered, what is in the plan, or does it include an additional "bonus" from the employer attempting to buyout your right to a lifelong income at retirement?
Though not always sure-fire, if it is the latter, you really should spend some time crunching the numbers or employ a financial professional to do so for you, prior to taking the money out. Said differently, if it is such a good deal for you as a former employee- why is the company offering it? Generally, companies have moved away from pensions because it is a very long term liability that they will be paying for the rest of the employee's life. That makes their balance sheet look terrible to investors or acquiring companies. On the employee end, it is not uncommon to see someone who would receive $500-$800 a month for life after 55- 60 years of age. Then the question becomes, would you rather have $26,000 all at once, or $6000+ a year for life in retirement, guaranteed until you die? Those are pretty compelling numbers.
Again, those are the general questions you should consider asking before rolling the money over, but for advice specific to your situation, you should consult a qualified financial professional.
Assuming it is a Defined Benefit Plan (DBA or Pension Plan), you can certainly "roll" into an IRA. In fact, based upon the information you gave about needing some of the money, you will almost certainly want to do that. This is because with company retirement plans like DBAs, 401(k)s, etc.. there is a mandatory 20% withholding taken off the top and sent to the government, whether you owe 20% tax or not. It will simply be netted against your tax return and you may be giving the IRS an interest free loan. You see, they penalize you for not paying enough, but they don't pay you interest when you overpay.
With an IRA distribution, you set the percentage amount withheld, whether it be 5%, 10% or even 0%. So, you can match more closely to what you think your tax liability will be. Just generalizing and without knowing your personal situation, I would take 1/2 the IRA distribution before the end of this year and the other 1/2 on January 2nd next year. This way you spread the tax liability over 2 years and it may not push you up into a higher tax bracket. This is to stimulate your thinking about the planning process.
Lastly, you need to get moving quickly on the IRA rollover from the annuity. Insurance companies are notorious for holding the money and slowing down the process with detailed, minutiae paperwork that needs to be Notarized etc. You may need some help on this to get it done and transferred into the IRA before year end. Then process a distribution request so the new brokerage firm (hopefully discount brokerage) distributes the 1st half by year end because they get bottlenecked with distribution requests in mid December before Christmas. Best of luck!
I would suggest cashing out the entire annuity, take care of your back taxes, and keep the remainder in a very liquid savings account. This gives you flexibility in terms of accessing the money in case of an emergency.
Assuming that you are under 59 1/2, you would have to pay income taxes and penalties on the withdrawal from your retirement plan. Hence, for the $13,000 that you plan to use to pay the IRS, you will net less than that. If you wanted to avoid the penalties and taxes, you would have to roll over your retirement plan into another retirement plan such as an IRA. Yes, a rollover from a company retirement plan into an IRA is allowed.
You may plan to pay for the tax debt differently. For instance, by reducing your husband's contribution to his retirement plan, you may be able to pay off your tax debt sooner. In the end, the income tax impact may be roughly equivalent. You will, however, avoid the early withdrawal penalty.
You do not need to be employed to do a Rollover. An IRA is appropriate. Be aware that if you take part of the money to pay off debt, you will owe taxes on it and depending on your age, there might be an early withdrawal penalty due as well.