Early lump sum withdraws from a pension plan come with significant consequences. They can include taxes, penalties, investment loss and reduced retirement benefits. Understanding the regulations and consequences can provide valuable retirement planning information.
Distributions from a pension plan carry significant restriction on when and under what circumstances they can be made. Moreover, the distribution types and circumstances determine if you will have taxes, penalties or both. Ordinarily, distributions may only be made if you separate from service, become disabled or a distribution may be made to your beneficiary if you are deceased. If one of these conditions exist, you are age 59 1/2 or younger and take a cash distribution, ordinary income tax will be due on the entire amount of the distribution plus a 10 per cent penalty. If you are over 59 1/2, the 10 per cent penalty does not apply but ordinary income taxes are due. Beginning at age 70 1/2, mandatory distributions of a portion of your account balance are required.
Cash distributions from a pension plan can be made after you separate from service or become disabled. If you take a distribution from a pension plan it may never be deposited into an IRA or other retirement account. So, in addition to the taxes and penalties, your retirement funds will be depleted. Further contributions are limited and the opportunity cost of forgone investment earnings all negatively impact your retirement.
Distributions from a pension plan may be rolled over to an IRA or a qualified plan, such as a 401(k). Any rollover IRA retains its tax-deferred status and can continue that status through multiple rollovers. You may be interested in transferring your pension benefits to a provider, such as Fidelity or Vanguard, or if you have IRAs from companies for which you have worked, you may be interested in consolidating your accounts by rolling them into a single IRA. As long as each IRA is a rollover IRA, the tax-deferred status will be retained.
It is critical to understand these consequences and make your decision carefully. While there certainly may be emergencies that can not be avoided, taking an early distribution of funds from a pension plan should be your last resort. The purpose of the plan is to provide funds for retirement.
Pension plans accumulated based on employer contributions only (with few exceptions). If you meet the criteria, and are able to take an early distribution, you should remember that those funds will not be replaced. That, in addition to the lost opportunity to grow the assets, result in a reduced retirement account.