What are the tax implications of taking a lump-sum distribution from a defined benefit pension plan instead of rolling it over in 2025?

When an employee leaves a company sponsoring a defined benefit pension plan (often a traditional pension or Cash Balance plan), they are typically offered the option to take a lump-sum distribution or roll the funds directly into an Individual Retirement Account (IRA) or another qualified plan.

Taking the lump sum without immediately rolling it over has significant, immediate tax consequences in 2025.

### Immediate Taxation and Withholding

If you receive the distribution directly (a 'cash-out' distribution) and do not roll it over within 60 days, the entire amount is generally treated as taxable ordinary income in the year received. Furthermore, because the funds have never been taxed (they grew tax-deferred), the plan administrator is required to withhold federal income tax immediately.

• Mandatory Withholding: For distributions paid directly to the participant, the plan administrator must withhold 20% of the taxable amount for federal income tax.
• Ordinary Income Tax: On your tax return for 2025, the full amount of the distribution (before withholding) is added to your gross income and taxed at your ordinary income tax rates.

### The 10% Early Withdrawal Penalty

If you are under age 59½ when you receive the lump sum, the distribution is typically subject to an additional 10% early withdrawal penalty on the taxable amount, unless a specific exception applies (such as separation from service after age 55, disability, or qualified domestic relations order).

Tax Liability Example (Under Age 59½, No Exception):

If you receive a USD 100,000 lump sum and are in the 24% tax bracket:

• Mandatory Withholding (20%): USD 20,000 withheld.
• Tax Liability (24%): USD 24,000 owed.
• Penalty (10%): USD 10,000 owed.
• Total Tax Due (Excluding State Tax): USD 34,000.

If you only received USD 20,000 in withholding, you would owe an additional USD 14,000 when filing your 2025 return.

### The Benefit of a Direct Rollover

If the lump sum is directly rolled over from the pension administrator to a trustee of an IRA or another qualified plan, no federal income tax is withheld, and the funds remain tax-deferred. This preserves the tax-deferred status of the entire amount, allowing the money to continue growing until required minimum distributions (RMDs) begin or until distributions are taken later in life.

If you received the check payable to yourself, you still have a 60-day window to deposit the entire amount (including the 20% that was withheld) into an IRA to avoid taxation and penalties. If you use other funds to replace the withheld 20%, you can recover the full tax liability when you file, as the IRS views the replacement funds as having been rolled over.

Consult IRS Publication 575, Pension and Annuity Income, for detailed rules on reporting pension distributions.