If your company offers a defined-contribution plan, there are several tax implications you should be aware of:

1. Retirement income is taxed as ordinary income.
2. If you make withdrawals from your defined-contribution plan before age fifty-nine and a half, a 10 percent penalty applies to principle and earnings (there are some exceptions).
3. There is a 20 percent withholding requirement on withdrawals made before age fifty-nine and a half from qualified plans. This means that if you withdraw $20,000 before age fifty-nine and a half, you will only receive $16,000 and the pension plan with keep the remaining 20 percent to submit to the Internal Revenue Service for tax purposes.
4. Certain loan provisions may apply.
5. Mandatory annual distributions begin after age seventy and a half.

Required Minimum Distributions

When saving for retirement, remember that the benefit of deferred taxes is offset by the fact that you must eventually pay taxes on your principal and earnings. Defined-contribution plans that defer taxes require that minimum distributions must begin by April 1 of the year following age seventy and a half. The distribution amount is calculated by dividing the account balance on December 31 of the previous year by the life expectancy. Note that there is a 50 percent penalty on minimum distributions that are not taken (see Table 8).

Table 8: Life Expectancy and Age

Age	Life Expectancy (LE)	Age	LE
70	27.4	75	22.9
71	26.5	76	22.0
72	25.6	77	21.2
73	24.7	78	20.3
74	23.8	79	19.5

Payout Options

Payout options are the ways that you can choose to receive your money at retirement. You can receive a lump-sum distribution, an annuity, or periodic payments, or you may roll the money into an IRA.

A lump-sum distribution gives you full control over future investing and spending. The disadvantage of this option is that taxes are due immediately on the full amount of the distribution. In addition, this type of distribution will not necessarily provide you with income throughout your retirement.

An annuity, which may be purchased either through an investment company or through an outside company, provides fixed payments, usually for life. However, an annuity does not usually provide a cost of living adjustment (COLA), and you must pay taxes on the amount you receive each year.

Periodic payments provide you with fixed payments at regular intervals. However, this type of distribution does not ensure that you will receive income throughout your retirement, because the money may eventually run out if you live longer than your planned periodic payments. Also, if payments are large, your tax rate may be quite high.

By rolling distributions into an IRA, you can continue to defer taxes until you make withdrawals. Once the money is in an IRA, you can direct the investment of the funds even more than when the funds were in a 401(k) plan. The only disadvantage of this option is that you must begin making withdrawals at age seventy and a half or you will incur a penalty.

Making Use of Your Defined-Contribution Plan

Once you know which investment vehicle is available to you through your employer’s defined-contribution plan, the next step is to choose the appropriate financial assets to include in this plan. Most people invest about 75 percent of their retirement assets in equities; in general, mutual funds provide the good diversification opportunities. Refer to the unit on investing for help in determining which assets to include in your retirement vehicle. Most company plans offer about ten investment options, although some plans offer significantly more.

As you make investment decisions, it is important to remember the principles of successful investing, the priorities of money, your investment horizon, your financial goals, and your risk-tolerance level. You should also consider other important issues, including annual expenses, administration expenses, transfer fees, and reallocation options and costs.