Pension Payments and Taxable Events

Cincitucky

Wife received a notice from her previous employer that she is eligible to receive her pension in the form of: annuity payments, a lump sum, or to postpone payments.

If either the annuity or lump sum is chosen, the payment would be in 2015. Is this a taxable event for the year 2015, meaning it wouldn't be included in our upcoming 2014 tax return? Our first thought is to take the lump sum on January 1st.

Cirira

If you take the cash on January 1st I believe it would be a taxable events for 2015, not 2014. A lump sum will generally have taxes taken out of it as well, but if they don't make sure to set aside around 30% of the lump sum to cover yourself.

tinwhiskers

This is really a talk to a CPA/CFA kind of question. I think people generally undervalue the certainty of annuities. Even if the method that will yield you the most $ over the long term is a lump sum, the certainty of income from an annuity+SS can let you burn your other retirement funds more aggressively in that age window where you are healthy enough to do stuff. Rather than end up dying on a bunch of cash because you were afraid of outliving your money.

Cincitucky

Unfortunately, this amount of money is rather negligible. If it was a life changing chunk of dough, we'd talk with a financial advisor.

Without saying the amount, its more like a nice Christmas bonus. Our concern was the timing of a payment and in which year it is considered a taxable event.

tinwhiskers

Unless you are maxing yours out you could probably role it into something tax-deferred like an IRA.

Daimar

Speaking only for Canada, the majority of the money you receive is taxed based on when you receive the cash, not when you earn it, so if you receive it in 2015 it will be taxed in 2015.

Thundyrkatz

The cash will be taxable to you in the year in which you receive it. So, if you receive it on or after January 1st in 2015 then it will show up on your tax forms for that year (due by tax filing day in April 2016 (assuming no extensions)). It will be taxed to you as income at your marginal tax rate.

You should find out if taxes have already been withheld or if that will be your responsibility. Also, you should find out if there are any penalties for receiving the income prior to a certain age like 59.5. Talking to a CPA or a Financial Planner could possibly help you avoid or mitigate those taxes and penalties.

If your talking 10,000 then its not unrealistic to expect to pay a penalty of 1,000 (10%) and taxes 1,500 to 3,000 depending on your tax bracket.

Cincitucky

Appreciate the feedback from everyone.

When I created the OP, I was going off one piece of paper that gave very few details on the payout options. Last night, I came across additional information, giving better details on what happens with each option. The lump sum choice is very close to what Thundykatz described. A 10% penalty for being under a specific age and 20% is taken out as tax.

Thanks everyone.

Thundyrkatz

Just 1 more point. If you have the option to roll this over to a new tax deferred account like an IRA. Then ideally the cash would go from the current custodian to the custodian of the IRA and never touch your hands. If that happens than you can avoid the taxes and penalty.

However if you take possession of the cash and then roll it over to an IRA (generally within 60 days of the day you receive it) you will have to roll over the full amount of the distribution and then reclaim the taxes and penalty that was withheld on your next tax return.

So if your lump sum was $10k, but you only got $7k in cash after taxes and penalties, then you will have to deposit $10k (that's $3k out of your own pocket) into an IRA and then get refunded the $3k difference on your next tax return.

If you just roll over the $7k then you will be assessed taxes and penalties on that $3k that you did not roll over!