Can Lump Sum Pensions Be Put Into an IRA?
Can Lump Sum Pensions Be Put Into an IRA?. When you receive a lump sum distribution from an employer’s pension plan, you have several options. If you hold onto the funds -- depositing them in your savings account, for example -- federal tax laws require you to declare the amount as income on your tax return. To avoid paying taxes on a lump sum pension distribution, transfer the funds into an eligible retirement plan or an individual retirement account (IRA). This process is known as a rollover.
Lump Sum Distributions
The IRS defines a lump sum distribution as a disbursement of a participant’s entire balance from an employer's qualified plan within a single year. Qualified employer plans include pension plans, as well as profit-sharing and stock-bonus plans. A distribution from a nonqualified plan, such as an annuity that you bought privately, does not qualify as a lump sum distribution.
To defer taxes on a lump sum pension distribution, instruct the employer to transfer the distribution directly into your IRA. The employer can also transfer the distribution to another an eligible retirement plan. For example, if your former employer is making the lump sum distribution, in most cases it can transfer the funds into your current employer’s retirement plan. Direct rollover funds are not taxable, but you must report the amount on your federal tax return.
If you do not take advantage of the direct rollover option, you can also defer taxes on a lump sum pension distribution by performing the rollover yourself. IRS rules require you to place the funds into an IRA within 60 days after you receive the funds. If you miss the deadline, you must declare the funds as income on your federal tax returns.
Rollover Tax Consequences
The IRS requires a mandatory income tax withholding of 20 percent on most distributions paid directly to individuals in a lump sum from employer retirement plans, even if you plan to transfer the funds to an IRA within 60 days. If you rollover the distribution to an IRA yourself and want to defer taxes on the entire distribution amount, you must add funds to your IRA equal to the withholding amount when you rollover the distribution funds. You’ll get the amount the employer withholds from your distribution check refunded to you when you file your federal tax return. However, the IRS considers the withholding amount to be a taxable withdrawal from the IRA if you don't add the same amount to the IRA. Because mandatory withholding does not apply to direct rollovers, it works to your advantage to have your employer transfer a lump sum pension distribution to your IRA.