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Prior employer terminated a pension plan. We'd like to take the lump distribution of 25,000 to pay some bills rather than roll over, but the taxes and penalty are 30%?

My husband's  prior employer terminated a pension plan, and we would like to take the lump sum of $25,000 to pay some bills. There is a rollover option, but again, we'd like to be out of debt. We knew there would be taxes, but not wanting to loose that much out the distribution- What, if any, are the options to minimize that burden? Thank you. 

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Level 15

Prior employer terminated a pension plan. We'd like to take the lump distribution of 25,000 to pay some bills rather than roll over, but the taxes and penalty are 30%?

If you don't roll the money over into a new qualified retirement plan of some kind, any money you hold back will be subject to regular income tax, plus state income tax, plus a 10% penalty.  Depending on your income and the state you live in, that could be as little as 22% total tax, or as much as 45%.  (10% penalty, 12%, 22% or 24% income tax, and 3-13% state income tax.)

The only tax reduction strategy specific to retirement contributions is to make a rollover to a new qualified plan within 60 days.  You must roll over the entire amount, even if some is withheld for taxes.  That means, if you take $25,000 and the brokers takes mandatory withholding of 20%, you get a check for $20,000, but must deposit $25,000 in the new account.  You would get the tax back as part of your tax refund at the end of the year. If you only put the $20,000 in the new plan, the other $5000 counts as a withdrawal and it will be taxable income on your tax return subject to tax and penalties (but you would get most of it back in your refund, since the tax on $5000 will be less than half that amount).

You can avoid the mandatory 20% withholding if you do a direct broker-to-broker transfer of the entire amount.


Any other tax reduction options are the same that are always available to anyone; make donations to charity, contribute to an IRA if you are eligible, and so on.

*Answers are correct to the best of my ability but do not constitute legal or tax advice.*
**If a post answers your question, choose it by clicking on "Mark as Best Answer".**

View solution in original post

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Highlighted
Level 15

Prior employer terminated a pension plan. We'd like to take the lump distribution of 25,000 to pay some bills rather than roll over, but the taxes and penalty are 30%?

If you don't roll the money over into a new qualified retirement plan of some kind, any money you hold back will be subject to regular income tax, plus state income tax, plus a 10% penalty.  Depending on your income and the state you live in, that could be as little as 22% total tax, or as much as 45%.  (10% penalty, 12%, 22% or 24% income tax, and 3-13% state income tax.)

The only tax reduction strategy specific to retirement contributions is to make a rollover to a new qualified plan within 60 days.  You must roll over the entire amount, even if some is withheld for taxes.  That means, if you take $25,000 and the brokers takes mandatory withholding of 20%, you get a check for $20,000, but must deposit $25,000 in the new account.  You would get the tax back as part of your tax refund at the end of the year. If you only put the $20,000 in the new plan, the other $5000 counts as a withdrawal and it will be taxable income on your tax return subject to tax and penalties (but you would get most of it back in your refund, since the tax on $5000 will be less than half that amount).

You can avoid the mandatory 20% withholding if you do a direct broker-to-broker transfer of the entire amount.


Any other tax reduction options are the same that are always available to anyone; make donations to charity, contribute to an IRA if you are eligible, and so on.

*Answers are correct to the best of my ability but do not constitute legal or tax advice.*
**If a post answers your question, choose it by clicking on "Mark as Best Answer".**

View solution in original post

Highlighted
Level 15

Prior employer terminated a pension plan. We'd like to take the lump distribution of 25,000 to pay some bills rather than roll over, but the taxes and penalty are 30%?

If you are usually eligible for the Earned income credit (EIC), the additional income could make you ineligible for EIC or reduce the amount of EIC you get, effectively increasing the effective tax rate on the distribution.