You get only one shot at choosing a payout plan. By Mary Beth Franklin, Senior Editor May 1, 2007 When it comes to making crucial decisions about retirement payouts, you don't get do-overs. Instead of checking off boxes and signing forms before rushing off to your retirement party, take time to weigh your options. Making mistakes "can be a very expensive learning curve," says Mark Cortazzo, head of Macro Consulting Group, in Parsippany, N.J. Avoiding them can save you thousands of dollars in taxes. Withdrawing money too soon. If you tap your retirement funds before age 59½, you'll owe a 10% early-with-drawal penalty on top of the federal and state income taxes you'll pay on each distribution. There are exceptions that let you withdraw your money early without a penalty -- but only if you follow the rules. For example, if you are at least 55 in the year you leave your job, you may be able to start taking distributions from your 401(k) without paying a penalty, withdrawing as much as you like (but you will still owe income taxes on your withdrawals). The key is to keep your money in your employer's plan when you retire. If you transfer it to an IRA, you'll lose the "55-and-out" option. That's what Jim Conrad of Huntertown, Ind., planned to do when he retired last fall after 33 years in the auto industry. But there's a catch: Your company plan isn't required to allow early periodic distributions. Conrad's plan didn't, forcing him and his wife, Colleen, to come up with Plan B. "We know we'll need to tap some of our savings for income," Conrad says. "We're just trying to figure out the best way." Advertisement Interrupting annual payments. So Conrad, 55, is considering another early-out strategy. If he rolls his 401(k) into an IRA, he can start tapping it penalty-free (but will still owe income taxes) as long as he takes "substantially equal periodic payments" based on his life expectancy for at least five years or until he's 59½, whichever is longer. There are three ways to calculate these so-called 72(t) payments (named after the section of the tax code that waives the penalty), all of which can be done using the free calculators at www.72t.net. Let's say you have $500,000 in your IRA when you begin taking distributions at age 56. The IRS life-expectancy table estimates that you will live another 28.7 years. Under the simplest minimum-distribution method, you would have to withdraw $17,422 the first year, then divide your subsequent IRA balances by your declining life expectancy for each of the next four years. The goal is to give yourself early access to some of your retirement savings without wiping out your account. The other two calculation methods would result in larger annual payouts of more than $35,000 per year. If you don't need that much money, you can split your IRA into separate accounts and set up a periodic-payment plan with just one of them. The reverse calculator at www.72t.net lets you plug in the amount you want to receive each year and then tells you how much you need to allocate to the account. Once you start, you can't change your mind. If you deviate from the payout schedule, you'll owe a 10% penalty retroactive to your first withdrawal, plus interest. Say you took out $75,000 in 72(t) withdrawals over four years, then stopped before reaching the five-year threshold. You would owe more than $8,000 in penalties and interest. Advertisement Taking a check. If you decide to transfer your 401(k) or other retirement assets to an IRA, make sure they go directly to the new custodian. If your employer cuts you a check, the company will be required to withhold 20% for taxes and you will have to roll over the entire amount -- including the 20% you didn't receive -- into an IRA within 60 days. Any money not deposited into the IRA would be treated as a taxable distribution, subject to taxes and early-withdrawal penalties. Mishandling company stock. Rolling over your 401(k) into an IRA is generally a good idea, but it may not be the right decision when you own company stock inside your plan. That's because distributions from IRAs, 401(k)s and other tax-deferred retirement plans are taxed at your regular income-tax rate, which can be as high as 35%. Sales of investments held longer than one year inside taxable accounts, however, are taxed at a maximum capital-gains rate of just 15%. To let you take advantage of lower tax rates, there's a special rule for what is called net unrealized appreciation. You're allowed to move your employer's stock out of your 401(k) when you retire or leave your job. But, again, you have to follow the rules precisely. First, you must take a lump-sum distribution of the entire balance in your 401(k). Then you roll all of the money, except the company stock, into an IRA; you deposit the stock into a taxable account. The money in the IRA won't be taxed until you start taking withdrawals. You'll owe income taxes on the stock you transfer (plus a 10% penalty if you're younger than 59½). But the tax will be computed based on what you paid for the stock, not its higher, market price. Advertisement When Bill Mayer retired from Warner Lambert after 33 years, he had accumulated more than 10,000 shares of company stock, worth more than $700,000, inside his 401(k). But his basis -- what he actually paid for the stock -- was only about $70,000. On Cortazzo's advice, Mayer transferred the stock to a taxable account and paid taxes on his basis at his regular income-tax rate. After that, all subsequent sales of the stock were taxed at the top 15% capital-gains rate. Mayer figures he saved more than $150,000 in taxes, which left him more money to invest. "Don't wait until the last minute," advises Mayer, who now lives in Estero, Fla. "Find someone who can help you put a strategy in place and handle all the details." Taking your lumps -- or not. If you're eligible for a traditional pension, you may be able to choose between receiving a monthly check for the rest of your life or taking a lump sum, which gives you more investment options when you roll it over to an IRA. Your decision should be based partly on health -- both yours and your company's. Advertisement If you have medical problems or longevity doesn't run in your family, you may want to choose the lump sum. Before you do, ask your employer whether you'd be giving up retiree health benefits or cost-of-living adjustments on a monthly pension check. Calculate how much monthly income you could receive if you used your lump sum to buy an immediate annuity (go to www.annuityshopper.com), then compare that to your monthly pension check. Men may come out ahead in this scenario because they have shorter life expectancies and receive larger monthly benefits from annuities sold by insurance companies. Women, on the other hand, may want to stick with company pensions, which are required to be gender-neutral. A lump sum could also be a good choice if there's a risk your company's pension plan is underfunded and might be taken over by the Pension Benefit Guaranty Corp. Although 90% of retirees in PBGC-managed plans receive their full pension benefits, higher-paid workers whose monthly checks exceed the limits of the government's insurance program ($49,500 a year for a 65-year-old whose pension is taken over in 2007) could come up short. Don't forget survivor benefits If you're married and choose to collect a pension check, you have to decide whether you want your spouse to receive survivor benefits. You'll get smaller monthly checks now, but your spouse will still get benefits if you die first. As an alternative, some people choose to take the larger pension benefit and buy a term life-insurance policy to provide for the surviving spouse. But that could backfire if the breadwinner outlives the term policy and then dies, leaving the survivor with nothing. Even if the policy pays off, it can be an "emotional train wreck" for the surviving spouse, says Mary McGrath, a financial planner and CPA with Cozad Asset Management, in Champaign, Ill. The survivor would have to deal simultaneously with a loved one's death, an end to monthly pension checks and a decision about how to invest the proceeds from the insurance company.