Pension Lump Sum Rules

by Cindy Quarters

A pension is a fund set up by your employer that accumulates funds throughout your working life, so that you will have money to live on once you retire. Ways you can take your pension are defined by the rules of your pension program. Common payout methods are monthly payments, where you get a portion of the total each month, and lump sum payments, where you get the entire amount at once. Not all pension programs allow lump sum payouts, so before you can even consider this option you should check the program rules for your pension to make sure you are eligible. Other things you should consider when taking a lump sum are taxes, penalties and how you will manage your money if you take a lump sum payout.

Eligibility

You are not eligible to take any kind of a payout on a pension through your employer until you are no longer working for that company. This means you must either change employers or retire before you can take a payout. You must typically also wait until you reach retirement age before you can request any kind of a payout, including a lump sum. While there are exceptions to this rule, in general you must be at least 59 1/2 before you begin to draw out any money from your pension fund, or in some cases 55, if you are no longer working for the company.

Taxes and Penalties

When you receive money from a pension fund, it counts as income for the year in which you receive it. This means that if you take a large lump sum payout you might be facing a very high tax rate on the money. Expect 20 percent of your funds to be withheld for taxes. Also, if you get your pension before you reach retirement age, another 10 percent will be kept back to cover the IRS penalties imposed for early withdrawal. You might be able to recover some of that when you file that year’s taxes, but because the lump sum counts as income for that year, you may also find that you owe even more than the 30 percent.

Strategies

If you want to receive your pension as a single lump sum but don’t want to have taxes withheld, you can roll it over directly from your company’s pension plan into another approved program, such as a 401(k) or an IRA. If the money doesn’t come to you but is transferred directly between trustees, you can avoid all withholding and penalties at the time of the transfer, even if you have not yet reached the retirement age of 59 1/2. The IRS also offers some programs that may give you a special one-time tax relief, depending on your age and other circumstances. The rules for this can be complicated, so it’s best to check with a tax accountant to see if you qualify.

Benefits

When taking a lump sum payout, you have the option to put it into an account that you can manage yourself. If you are a confident investor, this can be ideal, especially because the typical annuity payments will not keep up with inflation, and if inflation accelerates, your money may lose much of its buying power. By taking your pension as a lump sum and investing it where you see fit, you can work to ensure that your money continues to grow, plus, you are not limited by a fixed payout. This allows you to take more in some years and less in others, ideal for accommodating vacations and other special events.

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