A pension plan may have an option that allows you to take your entire pension benefit as a lump sum instead of receiving monthly payments. However, there are disadvantages to lump sum payments.
- If you or your husband takes a lump-sum payment, you may lose your retiree health insurance – sometimes right away, sometimes after your husband dies.
- If you and your husband decide to take a lump-sum benefit and invest it yourselves, you will not have widow’s benefits if he dies before you (and vice-versa).
Advantages of Monthly Payments
Advantages of opting for a monthly payment and not taking a lump sum include:
- You will receive a guaranteed monthly annuity for your lifetime.
- You will not be responsible for managing the investment of your lump sum payment.
- You will not be tempted to spend part or all of the lump sum instead of rolling it over.
When You Don't Have a Choice
In certain circumstances, a pension plan can require you (without your consent) to take your pension in a lump sum when the present value of the pension you have earned is less than $3,500.
- The pension plan must follow federal tax law regulations that state the interest rates the plan must use to calculate the present value of the pension.
- However, if the present value is greater than $5,000, you and your spouse must both consent to take the benefits in a lump sum.
Rolling Over Can Avoid Tax Penalties
If you receive a lump sum pension payment, you will have to pay taxes on the payment unless you roll it over into an individual retirement account (IRA) or other eligible plan. (For example, if you are changing jobs and your new company's pension plan accepts transfers)
- You can roll all or part of the lump sum payment into an IRA and defer paying taxes on that amount. Your pension plan can either transfer the payment directly to the IRA or send you a check, which you then put into an IRA or other eligible plan.
- If the plan directly transfers the lump sum payment, it will not withhold taxes.
- However, if the plan sends you the payment, it is required by law to withhold 20% for income taxes, even if you will not owe that amount on your income taxes. (You must then come up with the dollar amount of the 20% withholding and roll that over, or you will be liable for taxes on that amount.)
Tax Penalty for Receiving Payment Before Age 59 ½
In addition, if you receive a payment before you are 59 ½ years old and you do not roll it over, you may have to pay an additional 10% tax on the payment.
There are several exceptions, and you should check with the Internal Revenue Service to see if you qualify. Generally, the exceptions include receiving payment:
- because you have left an employer and you are over age 55;
- for disability retirement;
- in equal monthly payments over your lifetime (early retirement); or
- for certain medical expenses.