Whether voluntarily or not, this may be the year that you retire or change jobs. As a result, you may be eligible for a lump-sum distribution from a savings, profit-sharing or other type of defined-contributions plan. You also may be eligible for a lump-sum payment from a defined benefits form of retirement plan, if your employer is one of the minority offering this alternative to a monthly pension check.
If you're like many other employees in such circumstances -- lump-sum distributions are approaching an annual rate of $100 billion, partly because of corporate "downsizing" -- you could have $50,000 to $100,000 or more before long. That could be more money than you've ever had in your hands before.
You'd have two choices:
1. Take the distribution in 1991, pay taxes on it -- possibly at a reduced rate -- and have the cash available to invest and/or to spend.
2. Roll it over tax-free into an individual retirement account (IRA) and postpone taxes until you begin to take the money out. The IRS requires you to start taking distributions by April 1 of the year following the year in which you reach age 70.
By rolling it over, you'd be able to build the sum staying in the IRA into a larger one. You wouldn't have to worry about taxes on any income or capital gains that are reinvested. (If you're changing jobs, you might be able to roll over the IRA assets tax-free to your new employer's retirement plan.)
Whether you take the distribution or move it into an IRA, the money should be used to supplement your retirement income from Social Security and other sources. Because tax considerations are essential to maximizing your benefits, make sure that you get proper tax advice in choosing between the two.
If you determine that you'd be better off rolling over the money, what do you do with it?
Just as mutual funds are the favorite place for many of the 6 million people who make annual IRA contributions, they also are preferable for a large share of those rolling over lump-sums. No one knows how much of the fund industry's $127 billion of IRA assets is in rollover accounts, but industry leader Fidelity estimates that 20 percent of its IRA accounts, accounting for about 40 percent of its IRA assets, were begun with rollovers of lump-sums from employers' plans.
Mutual funds may best serve your needs because they'll enable you to tailor a blend of assets, based on how much money you expect, how much time you have to build up the principal, and how much income you'll want over the years. (Retirement planning kits, such as those offered for free by T. Rowe Price at 800-638-5660 or by Fidelity at 800-544-8888, will help you estimate income flows and requirements, among other things.)
Allocating your IRA assets among money-market, bond and equity mutual funds to meet your investment goals, you can be secure in the knowledge that you can change the
mix -- or the funds -- whenever market conditions, fund performance or your needs warrant.
Brokers, financial planners, and others will be happy to help you to choose funds, but you can become your own money manager and save on sales charges and other fees. You'll be able to develop a list from which to choose funds by reading a reference work such as "The Handbook For No-Load Fund Investors," as well as prospectuses, shareholder reports and promotional pamphlets published by fund families such as Scudder, Vanguard, Fidelity and Price.
Once you get your check, be sure to comply with the IRS condition for a tax-free rollover by moving the money into an IRA fund within 60 days. That's easy: just put it into a money-market fund -- ideally, but not necessarily, a fund sponsored by one of the fund families offering bond or equity funds that you're considering.
In weighing the alternatives, remember some basic principles:
1. Inflation can have a major impact on the adequacy of your retirement income. If, for example, you assume a 4 percent constant rate, your money will lose one-third of its purchasing power in 10 years.
2. Money-market funds involve the least risk of loss of principal, but their yields -- as yields of money-market instruments generally -- do little more than stay ahead of inflation.
3. Bond funds provide higher yields -- how much higher depends on maturities and levels of credit quality. Don't incur more market or credit risk than you can tolerate.
4. Well-managed equity funds should give you a higher total return over the long run. They also should provide better protection against the erosion of your purchasing power. How much of your retirement assets should be invested in equity funds depends largely on the size of your lump-sum and your risk tolerance.
Invest in your chosen bond and equity funds in installments to avoid the risk of buying their shares at a market peak. If you choose funds within the same family as the money-market fund, you can request switches any time by telephoning. If you also choose funds from other families, you must request in writing that the trustee of your money-market fund make a transfer to the other funds. That's all you have to do.