Lump Sums Taxed as Ordinary Income

Generally, if you receive a lump-sum pension distribution, any portion that is not rolled over into an IRA will be taxed as ordinary income. This can have the effect of pushing you into a much higher tax bracket than you'd usually face.

If you were born before 1936 and received a lump sum distribution from a qualified retirement plan, you may be eligible to elect optional methods of figuring the tax on the distribution which will end up saving you money. The part from active participation in the plan before 1974 may qualify as capital gain subject to the capital gains tax rate. The election is claimed by filling out Part II of IRS Form 4972, Tax on Lump Sum Distributions. Any amount earned after 1973 or not reported as capital gain is treated as ordinary income.

Planning Tools You can download Form 4972 to aid in your financial planning.

In addition, a ten-year averaging option is available to figure the tax on the ordinary income part. The averaging treatment usually has the effect of taxing your payment in a lower tax bracket than you'd otherwise face.