Rules on Cashing Pensions
When you cash in a pension plan, you receive your account proceeds as a lump sum. Normally, you cannot withdraw money from a pension that your current employer funded while you are still employed. Once you leave your job, depending on the kind of pension plan that you have, you may have the option to cash in your account, but in many instances you cannot liquidate a pension until you reach retirement age.
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Pensions
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In the United States, pension plans fall into two categories: defined benefits and defined contribution plans. Your employer contributions to a defined benefit plan may vary, but you receive a specific benefit in the form of monthly pension payments once your retire. In a defined contribution plan, your employer makes fixed contributions to the account but funds are invested in subaccounts containing stocks or mutual funds and your pension benefits depend on the performance of these subaccounts. SIMPLE IRAs, 403(b) plans and 401(k)s are defined contribution plans while defined benefit plans are usually referred to as "traditional" pensions.
Withdrawals
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Under federal law, you can access funds inside your pension when the latter of three events occurs: you reach the age of 65, you leave your job, or you complete 10 years of service with your employer. For the first of these milestones, your company can opt to lower the retirement age from 65 to an earlier age, but an employer cannot increase the retirement age past 65. If you choose to start receiving benefits then your employer must start disbursing your pension benefits within 60 days of the last of these events occurring. However, the law states that your employer must start paying you benefits but it does not state that your employer must allow you to cash in your account.
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Considerations
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Most companies allow you to cash in defined contribution plans, such as 401(k)s and SIMPLE IRAs, when you leave your job. Enabling you to cash in the account means that your former employer no longer has to cover the administrative costs of maintaining the account. You can move the money into another tax-sheltered retirement account or just accept it as taxable income. However, many defined benefits plans have no provision for you taking your benefits as a lump sum. Some employers do allow you to cash-in defined benefit plans, but you receive less when you get a lump sum than you would eventually receive if you accepted the money over many years in the form of monthly payments.
Tax
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Regardless of your age, you have to pay income tax on your pension when you cash it in unless you roll the funds into another tax-qualified retirement account. The federal government also assesses a 10 percent penalty if you withdraw pension funds before you reach the age of 59 1/2. However, if you have a qualifying disability or you suffer a separation from employment after reaching the age of 55, then you do not have to pay the penalty tax, but you do pay income tax. You can also get the penalty tax waived if you use the money to pay for allowable medical costs or if you make a payout as the result of a divorce decree or similar court-ordered action. On a SIMPLE IRA, the penalty tax rises to 25 percent if you cash in your account within 24 months of your employer first funding it.
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References
- United States Department of Labor: What You Should Know About Your Retirement Plan
- IRS.gov; 401(k) Resource Guide - Plan Sponsors - General Distribution Rules; March 2011
- IRS.gov: Retirement Plans FAQs Regarding 403(b) Tax-Sheltered Annuity Plans
- IRS.gov; Retirement Plans FAQs Regarding SIMPLE IRA Plans; May 2011
