Expert: Allen - 2/4/2012

Question
Hi Allen,
I'm going to retire this June (2012).I will be 57 years old. I will be receiving a pension through my union. Half of my pension is a one time lump sum distribution which I can rollover or cash out. If I take the money instead of rolling it over is there a One-Time Capitol Gains exemption that I and my wife can claim so that we don't have to pay the 20% tax on the money?

Answer
If the money is paid to you - it will be subject to federal income tax, state income tax (if you live in a state that has an income tax) and a 10% excise tax for money received before age 59 1/2. The trustee will automatically withhold 20% as an estimate of the amount that will be due the federal government for income tax and excise tax. This is an estimate required by law. The actual income tax will be based on your income tax bracket and in most cases will be higher than 20%. (The trustee will allow you to elect to have more than 20% withheld, but not less.) In certain states the trustee will automatically withhold a certain amount as an estimate of the amount that will be due the state.

If the money is rolled to an IRA - no tax is withheld. When the money is withdrawn from the IRA, it will be subject to the same taxes as stated above. So you will not avoid the tax. You will only avoid the withholding. Some people use this technique to avoid withholding. However, I believe it is not a good idea as taxes will still be due and penalties may apply if the payment is not made until the time you file your income tax return for 2012.

Sorry that I can't give you a better answer. There is just no way to avoid tax on pension distributions.