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Collecting on a lump-sum pension payout


Dear Tax Talk,
I am going to be 55 years old and am thinking of retirement. I am planning on taking a lump sum from my pension plan, which is around $330,000. If I roll it into an IRA, can I start withdrawing this money without penalty? And what about tax consequences? -- Berg

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Dear Berg,
It's all about the tax consequences isn't it?

When an individual separates from employment, he usually has the option of taking his retirement account in a lump sum or an annuity over various time frames. Most folks prefer to take the lump sum distribution and roll it into an IRA that allows them to gain control of all the funds and invest as they see fit. The roll out of the funds from the pension plan to the IRA is tax-free. By annuitizing the funds, you guarantee yourself a set level of income for a period, such as your expected life span or that of yours and your spouse's.

If you retire after reaching age 55, you can take the full amount of the lump-sum distribution without being subjected to the 10-percent penalty for early withdrawals. However, this is generally not recommended because you'll end up owing a lot of taxes on money that you probably don't need all at once. Therefore, the rollover to the IRA is preferable.

Once the funds are in an IRA, you can begin withdrawing the funds in a fixed periodic payment prior to reaching age 59½ without incurring the additional 10-percent penalty on early withdrawals. Once you start receiving these payments, you must continue receiving the periodic payment for five years or your prior distributions can be subject to the 10-percent penalty.

For example, assume you decide to take the IRA balance over your expected life span. Based on Table I of Internal Revenue Service Publication 590, your expected life span is 29.6 years, so your first distribution for your first year would be $11,148.65 ($330,000/29.6). You can take these funds monthly or annually and just pay regular income tax on the funds without paying the penalty. You should also consult Publication 590 for other distribution options.

-- Posted: May 14, 2004




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