Kelly Bullis: Will 10-year averaging work for you?

Now here’s a tax trick for some folks. If you were born before Jan. 2, 1936 and you’re taking a lump-sum distribution from a qualified retirement plan, you may use an OLD tax strategy, long forgotten, called “10-Year Averaging.”

10-Year Averaging is exactly what it says, in effect, you’re treated as if you’re receiving the payout over 10 years for tax purposes. Why is this helpful? Tax rates go up when your income goes up, and by basically coming up with the top applicable tax rate if you only reported 1/10^th of the lump-sum amount, your total tax could be significantly lower!

Unfortunately, the tax rates used in 10-Year Averaging are not the current tax rates, but the ones in effect in 1986. (FYI, the top tax rate in 1986 was 39.6%, the current top tax rate is 37%.) But wait, there’s more! (Sound like one of those infomercials?) Any part of the distribution attributable to participation in a plan before 1974 is taxed at a flat rate of 20%.

To qualify, the distribution must be from a qualified retirement plan or annuity. IRA distributions do NOT count. Also, the distribution must be the entire plan balance (not including employee contributions) all in one year. Three more limitations apply…1. The plan participant must have been a participant in the plan for at least five years before the distribution 2. The plan participant can’t have used the income averaging provision for any previous distributions after 1986 and 3. The distribution must be payable due to the employee reaching at least age 59 ½ on account of a common law employee’s separation from service, OR due to the employee’s death, OR after a self-employed individual has become disabled.

An alternative to 10-Year Averaging is to rollover part or all of the Plan distribution into an IRA. The new IRA account must be distributed under the Required Minimum Distribution (RMD) rules during the plan participant’s life-time, and, according to the recently passed SECURE act, the beneficiaries must do so within ten years of the account owner’s death.

Example: Let’s say you’re married and got a $1 million lump-sum distribution on a plan that you began participation in 1975. If you paid the tax in 2020 without 10-Year Averaging, the tax would be about $308,000. If you elected to use the 10-Year Averaging, the tax would be about $242,000 (using the 1986 tax table). That is a tax savings of $66,000.

Did you hear? Ecclesiastes 5:1 says “When goods increase, they increase who eat them, and what advantage has their owner but to see them with his eyes?”

Kelly Bullis is a Certified Public Accountant in Carson City. Contact him at 882-4459. On the web at BullisAndCo.com Also on Facebook.