It is an unfortunate fact of life that employers sometimes choose to downsize their work forces. There is the possibility that at some point in your career, you will be offered a buyout as an incentive to leave your job before you are ready to retire. If you have a 401(a) retirement savings plan where you work, it will probably be included in any buyout offer. It’s important to know your options before you accept the offer so you can protect your long term financial interests.
Any retirement plan set up under section 401 of the Internal Revenue Code is a type of 401(a), including 401(k) plans. When a tax-deferred plan is designated as a 401(a), employers have flexibility in establishing the terms and conditions of the plan that may be unavailable under more specific provisions like 401(k). In general, employers using a 401(a) plan can choose to make contributions and decide whether or not to include employee contributions on either a voluntary or mandatory basis. Employee contributions are made through salary deductions before payroll taxes are calculated, so contributions are not taxed.
Buyouts, also called early retirement packages, are incentives companies offer employees to encourage them to leave and are often used as an alternative or precursor to layoffs. With regard to 401(a) plans, buyout offers typically mean giving employees lump-sum payments of the balances in their accounts. Buyouts are not compulsory, so you may choose to accept or reject the offer. You must be given at least 45 days to determine what is in your best interests and make your decision.
If you choose to accept a buyout offer, you do not have to take the funds in your 401(a) plan as a lump-sum payout. Instead, you can roll the funds into another tax-deferred retirement plan such as a 401(k) or traditional IRA. For many people, a rollover is a better option because all money distributed from a 401(a) is taxable income for the year in which the distribution takes place. In addition, if you are under 55 years of age, you may be assessed a penalty tax of 10 percent on a lump-sum payout. With a rollover, you incur no tax liability.
401(a) buyouts are normally only one part of a more comprehensive early retirement package. Before you make any decisions, it’s a good idea to consult a financial advisor. You need to take into account alternative job prospects, the impact of leaving on health care benefits and other issues in addition to the effect on your 401(a) plan. It’s likely you will want to keep the 401(a) funds in a tax-deferred account. Besides the immediate tax consequences noted above, by not withdrawing the funds, you allow them to continue to grow tax-free until you are ready to start taking distributions.