Older gentleman sitting in his arm chair reading about retirement savings.

Pension lump sum considerations

Factors that can help determine if a lump sum may be right for you include retirement savings, pension lump sum tax rules and life expectancy.

Pensions provide a guaranteed lifetime income at retirement and, if elected, an income to your surviving spouse. However, there may be situations where taking a lump sum payment is more beneficial. Each person's situation is unique, but here are some general factors you’ll want to consider as you weigh your options.

Retirement savings

It may sound attractive to take a lump sum payment and use it to travel or to pay off debt but consider whether you’ll have enough money to live on long-term.

The first thing you’ll want to consider is the amount of money in your retirement savings. Is it enough to live on in your retirement years? What other income streams may be available to you? Do you plan to get a part time job? Do you plan to turn your lifelong hobby into a business?

Pension lump sum tax rules

Next, you’ll want to consider how the tax consequences might affect your decision.

Income tax

All money received from a pension is taxed as ordinary income, regardless if you receive monthly payments or take it as a lump sum. Whether you get taxed immediately upon taking the lump sum, or taxed later, depends on what you do with the money when you receive it.

  • Taxed immediately: If the money isn't rolled over into a tax-deferred account, you'll pay ordinary income tax on the amount of the lump sum when you receive it.
  • Taxed later: If the money is rolled over into an Individual Retirement Account (IRA), you won’t be taxed at that time; however, any distributions from the IRA will be taxed as ordinary income.

Estate tax

Your decision to take a lump sum payment affects whether or not your pension will be included as part of your taxable estate.

  • Excluded from estate tax: Pension payments will not be included in your taxable estate if the income payments stop at your or your spouse's death.
  • Included in estate tax: With the lump sum option, the remaining value of the account will be included in your estate tax.

Life expectancy

Consider how many years you expect to live.

If you’re in ill health or have a family history of a short life expectancy, taking a lump sum may be an attractive option. However, there’s a risk you may outlive the funds, depending on the investment performance and how much is needed for income.

You can't outlive the pension income. If you’re in relatively good health and anticipate having many years left, it may be more beneficial to consider taking the pension payments.

How much money are we talking?

The earlier you are in your career and/or tenure with the company, the smaller your pension lump sum offer might be — if it’s a trivial amount; you may want to consider taking the lump sum offer and investing it for your future.

How are your money-management skills?

Pensions provide a guaranteed fixed income stream, and your employer assumes the investment risk when making defined benefit pension payments. When you take a lump sum, you assume the risk of investing the funds to generate retirement income.

Fluctuations in the market and changes in interest rates can have an impact on the future value of the lump sum and your available income. Consider if you are willing to take the risk.

What’s the plan for your legacy?

With pension income, generally nothing remains for your heirs after you and your spouse pass away (unless you elected your pension over a certain period of years).

With the lump sum amount, any remaining funds can be used to leave a legacy to your heirs or even a favorite charity.

Consult with a professional

A financial professional can help discuss your options as you decide what’s best for you.

The information in this article was obtained from various sources not associated with State Farm® (including State Farm Mutual Automobile Insurance Company and its subsidiaries and affiliates). While we believe it to be reliable and accurate, we do not warrant the accuracy or reliability of the information. State Farm is not responsible for, and does not endorse or approve, either implicitly or explicitly, the content of any third party sites that might be hyperlinked from this page. The information is not intended to replace manuals, instructions or information provided by a manufacturer or the advice of a qualified professional, or to affect coverage under any applicable insurance policy. These suggestions are not a complete list of every loss control measure. State Farm makes no guarantees of results from use of this information.

Neither State Farm nor its agents provide tax or legal advice.

A 10% tax penalty generally applies for withdrawals from tax-qualified products and/or non tax-qualified annuities before age 59 1/2.

Prior to rolling over assets from an employer-sponsored retirement plan into an IRA, it's important that customers understand their options and do a full comparison on the differences in the guarantees and protections offered by each respective type of account as well as the differences in liquidity/loans, types of investments, fees, and any potential penalties.

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