Taxes on an Early Pension Buyout

Taxes on an Early Pension Buyout
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Companies can benefit from offering employees an early retirement, because slashing the number of employees reduces compensation costs. Employees have something to consider when presented with a buyout offer, however. The way that pension assets are taxed is based on the size of the payout and also the manner in which individuals choose to receive the benefits. The two primary ways are in a one-time payment or in an annuity-style distribution over the course of the retiree's life.


When an employer offers a pension buyout to certain employees, the company is giving these workers a chance to retire early. Upon retirement, employees become entitled to early pension benefits that would be normally be received at the standard retirement age. Employees do not need to accept a pension buyout but may choose to do so. Taxes on retirement income are often deferred throughout a person's employment. Whether an individual chooses to receive a pension buyout or retire at the traditional age, those benefits become subject to tax.

Lump-Sum Payment

Taxes are charged on a lump-sum pension payout during the year the money is received. There are ways to delay those tax obligations, however. One such tactic is to transfer the pension benefit to an individual retirement account. In doing so, the assets are not subject to taxation right away. Instead, when money is withdrawn from the IRA, an individual is taxed according to IRA regulation, according to the "Smart Money" website. Also, pension assets transferred to an IRA are taxed especially favorably for individuals born in 1936 or later.


Benefits from a pension buyout that are paid in an annuity style, which are monthly distributions, are taxed as regular income. It is common for employees and employers to make cash contributions to a pension throughout an individual's tenure with a firm. If those deposits were taxed when the contribution was made, the money is not taxed again upon retirement, according to the Internal Revenue Service website. Employers and employees may also make tax-free cash deposits to a pension, in which case those assets become taxable as income upon retirement.


It may be in an employer's best financial interest to offer pension buyouts to employees, but workers may have other plans. When retirement is very near, it is reasonable to accept a pension buyout, according to financial adviser Mark Cortazzo from Marco Consulting Group cited in an article on the "Kiplinger" website. Otherwise, individuals who remain years away from a planned retirement might be less inclined to stop working unless there is little future at the company. For example, if an employer is at risk of bankruptcy, which could inspire early pension buyouts, it might be prudent to accept a buyout and seek employment elsewhere, according to the article.