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Effects of disability on retirement planning

Social security benefits, retirement plans, and personal Keogh or IRA funds are affected disability. When a person is totally disabled and pronounced unable to work at any meaningful job, social security benefits are payable after a waiting period if the person is over 50. Ordinarily, a person must reach 59 1/2 before any prior contributions to personal Keogh or IRA retirement plans can be withdrawn without a penalty. However, disability or death of the plan holder voids the 59 1/2- year requirement. Company or governmental pension plans may include different provisions, but many provide benefits earlier than normal retirement if a person is disabled.

Income taxes, however, will still be due on money withdrawn from Keogh or IRA plans even though the owner is disabled. Cash contributed to Keogh or IRA plans escapes income tax at the time it is sequestered in an approved plan. When that cash is withdrawn along with any earnings accumulated tax free in either a Keogh or Ira, the person is liable for taxes on all withdrawals.

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Suppose a person is determined to be totally disabled at age 54 and has been contributing to a Keogh plan for years. If all the funds are withdrawn from the plan in a lump sum, the owner has the option of figuring the tax on a favorable 10-year-averaging plan. Under these rules the total amount drawn is divided by 10 and the tax rate applicable to a single person is applied. That amount is then multiplied by 10 get the total tax. Ten-year averaging allows Keogh owners to avoid a peak tax in one year.

Ten-year averaging is not available to IRA owners, although normal five-year averaging can be used to avoid a peak tax rate for one year. If Keogh plan funds are rolled over into an IRA, 10-year averaging is not available when the funds are later withdrawn. Even a partial withdrawal of Keogh funds voids the possibility of 10-year averaging later when all remaining funds are withdrawn.

Either Keogh or IRA funds may be withdrawn over as many years as desired with one limitation (see below). Thus, a disabled person could withdraw funds over 10, 15, 20 or more years and pay income taxes on the funds withdrawn as part of the tax liability for each year. A plan for stretching out the withdrawal of funds could avoid even more income taxes than the favorable 10-year- averaging option.

The one limitation on withdrawal of funds over a period of years applies equally to Keogh and IRA plans. If a person retires after 59 1/2 or retires earlier on disability and does not withdraw funds until age 70 1/2, withdrawal must begin that year. The number of years during which withdrawals are made must not exceed the person's normal life expectancy.

A major reason for withdrawing all funds from either a Keogh or IRA in a lump sum is to invest those funds where they will provide more income than if they remained under the control of a Keogh or IRA plan trustee. Whether lump sum withdrawal makes sense for you depends on where your Keogh or IRA funds are invested and how much income they are generating. If 10-year averaging is not available to you, examine a trade-off to determine whether a yearly withdrawal over an extended period to reduce taxes will produce more spendable dollars than taking out a lump sum, paying the taxes, and investing the remaining funds to earn a higher return. Your other taxable income, the rate of return being earned on Keogh or IRA funds, and alternative investments for earning a higher yield will all affect your decision.

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