Employers in the United States often enable employees to enroll in either defined contribution pension plans or in defined benefit plans. The Internal Revenue Service allows contributions into both account types to grow on a tax-deferred basis; you can make withdrawals once you retire. The IRS uses age 59 1/2 as the retirement age for tax purposes — you normally incur a 10 percent penalty if you withdraw pension funds prior to that age. However, in certain situations, you can access your pension funds before you retire and even before you reach age 59 1/2.
In a defined benefit plan, your employer makes annual contributions. These contributions normally accrue interest at a fixed rate. The precise details of defined benefit plans vary, but in general, you begin to receive income payments from the pension plan when you reach the age of 65. The payments are predetermined and not subject to change. However, if you leave your job before reaching the age at which your benefits begin, your employer may allow you to cash in your pension and accept the balance of your account as a taxable lump sum. Plans often don't include such a feature, in which case you must wait until you reach the age at which benefits begin. Thereafter, you receive benefits based upon the balance of your account at the time you left your job.
Defined Contribution Plans
When you enroll in a defined contribution plan, your employer makes regular contributions to your pension but offers no guarantees as to your future withdrawal benefits. In certain instances, such as those involving 401ks, you can also contribute to the account. When you leave your job, you can roll your pension money into another tax-sheltered account or you can cash it in. You must pay income tax on the amount withdrawn, as well as a tax penalty if you're under 59 1/2. Employers with 100 or fewer employees sometimes offer pension plans called SIMPLE IRAs. With these plans, the premature withdrawal penalty amounts to 25 percent if you access the money before 59 1/2 or within two years of your employer creating the account.
Generally, you can't access your defined contribution plan while still employed, but if you're employed and over 59 1/2, your employer may allow you to make an in-service withdrawal. You can withdraw money from your pension to move to another tax-sheltered account or you can just make a taxable withdrawal. You can also access money in your pension plan by taking out a 401k loan: You can withdraw up to $50,000 in the form of a 401k loan, although you must repay the money within five years. Not all employers allow plan participants to take out 401k loans.
If you access your pension pot prior to retirement age, aside from tax ramifications, you also have to contend with your employer's vesting schedule. A vesting schedule determines how long it takes for your employer's plan contributions to become your property. In a 401k, it takes up to six years before your employer's contributions are fully vested. You lose the nonvested portion of your pension when you make a premature withdrawal. On a defined benefit plan, it can take up to seven years for your employer's contributions to become vested. Therefore, you may lose more than you gain if you access your pension early.
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- United States Department of Labor: FAQs About Cash Balance Pension Plans
- 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 SIMPLE IRA Plans; March 2011