An employee may choose to receive funds from his qualified retirement account in several ways, including a lump-sum payment. Many employers automatically withhold 20 percent of a lump-sum distribution to pay federal taxes owed by the recipient of the disbursement. The Internal Revenue Service determines the exact amount of tax a person owes on a lump-sum distribution based on several factors, including the recipient’s date of birth and the dates of account deposits, however.
In order for the IRS to view a disbursement from a qualified, employer-sponsored retirement plan as a lump-sum distribution, a person must receive all of the funds in a single tax year. The IRS requires a recipient to exhaust the balances of every qualified pension, profit-sharing and stock bonus account administered by the same employer as well.
Born Before 1936
If a retirement plan participant was born before Jan. 2, 1936, the IRS may allow him to choose between five methods of calculating the tax owed on a lump-sum distribution if he satisfies certain criteria. The recipient of a lump-sum disbursement may treat the taxable portion of the lump-sum that predates 1974 as a capital gain that the IRS will tax at 20 percent and the balance of his distribution as ordinary income, for instance. Alternatively, the IRS may allow a lump-sum recipient to claim the entire lump-sum disbursement as ordinary income.
The IRS views lump-sum distributions made to individuals born after Jan. 1, 1936. as nonperiodic disbursements. If a person receives a nonperiodic distribution that is eligible for deposit into another qualified retirement account, such as a traditional IRA, 20 percent of the amount distributed is usually withheld to pay taxes owed by the recipient on the amount he received. If a person receives an ineligible distribution, his employer will usually withhold 10 percent of the disbursement.
The IRS allows a recipient of an ineligible nonperiodic distribution to waive the withholding of taxes if he provides proof of his residency in the United States or one of its possessions or certifies that he lives abroad for reasons that do not include tax evasion.
If a person requests that his former employer roll or move the funds in his retirement account into another qualified account or another employer’s plan, his previous employer will generally not withhold funds to pay taxes. If an employer sends a lump-sum distribution to a recipient who subsequently decides to deposit the funds into a qualified account within 60 days of receiving the disbursement, the IRS allows the individual to deposit additional funds into the new account to make up for the 20 percent his employer withheld at the time of the initial deposit into the new account. Under these circumstances, the IRS applies the money withheld by the person’s employer against the amount of tax the person owes when he files his federal return.
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