Distribution Rules, Alternatives And Taxation - Lump Sum Distributions

Lump Sum Distributions
A lump-sum distribution is a one-time payment for the entire amount due, rather than breaking payments into smaller installments. Some lump-sum distributions receive special tax treatment.

Under many qualified plans, participants upon retirement have a choice between selecting a lump-sum payment or a series of annuity payments, usually for the remainder of their lifetime and the beneficiary's.

Distributions from qualified plans are treated as a lump-sum, if the following requirements are met:

  • The total plan balance is distributed over the same tax year.
  • The distribution is made as a result of the employee:
    • Attaining age 59.5
    • Being deceased (applicable to beneficiaries)
    • Separating from service (not applicable to self-employed individuals - but applies to their common-law employees)
    • Being disabled (applicable only to self-employed individuals)
  • The distribution occurs after five years of participation (this requirement is waived for beneficiaries).

Considerations:

  • Present Value Comparison – The value of the lump-sum compared to the present value of annuity payments over the life expectancy of the participant and, if applicable, the beneficiary.
  • 10-year Forward Averaging – A participant born before Jan. 1, 1936, is eligible to elect this favorable tax treatment. It treats lump-sum distribution as if it occurred over a period of 10 years, resulting in the distribution being taxed at a lower rate than it normally would.
  • Financial Health of Plan Sponsor – A Retiring individual worried about the financial health of their plan sponsor, whose annuity payment amount would exceed the maximum benefit guaranteed by the Pension Benefit Guaranty Corporation, may want to consider a lump-sum payment.
  • Investment Control – The recipient of the lump-sum distribution controls how the assets are invested.
Annuity Options


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