Mistakes you can't afford to make on retirement payouts

Making mistakes when it comes to taking retirement payouts can be costly. Avoiding them can save you thousands of dollars in taxes.

• 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 percent. Sales of investments held longer than one year inside taxable accounts, however, are taxed at a maximum capital-gains rate of just 15 percent.

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 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 percent penalty if you're younger than 59 1/2). But the tax will be computed based on what you paid for the stock, not its higher, market price.

• 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. Your decision should be based partly on health — both yours and your company's.

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 because they have shorter life expectancies and receive larger monthly benefits from annuities sold by insurers. Women, on the other hand, may want to stick with company pensions, which are required to be gender-neutral. A lump sum may also be a good choice if there's a risk your company's pension plan is underfunded and could be taken over by the Pension Benefit Guaranty Corp.