How Do You Reduce Taxes on a Retirement Lump Sum Payment?


Quick Answer

To reduce taxes on a retirement lump sum payment, report the taxable part of the distribution made before 1974 — as detailed on the 1099-R form — as capital gains or roll the money into another qualifying retirement account so that it is not taxed, advises the Internal Revenue Service. To do this, you must have been born before Jan. 2, 1936.

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Full Answer

Investors have 60 days from the date of their distributions to rollover their funds into an individual retirement account or another type of qualifying retirement account, states the IRS. Funds rolled over in this period are not taxed. However, regardless of whether or not the recipient plans to rollover his distribution, the fund administrator reserves 20 percent of the lump sum distribution as a mandatory income tax payment.

The prospect of a large tax bill may deter some people from taking their retirement benefits in a lump sum rather than accepting monthly annuity payments, but in some cases, lump sum payments may be more financially advantageous than monthly payments, explains Bank Rate. Most annuities are not indexed to inflation, and as a result, the effective value of fixed monthly annuity payment falls over time. In contrast, lump sums can be invested in vehicles that pay a profitable interest rate.

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