How Pensions Work
Pensions, often referred to as defined benefit plans, are increasingly rare employer-based retirement funds designed to give employees a steady stream of income in retirement.
Key Facts About Selling Your Pension:
- At retirement age, you become eligible for regular pension payments based on your salary and years of service.
- Selling or cashing out pensions is not allowed for most federal pensions, but non-federal pensions may offer cash-out options.
- Pension payouts can be structured as a lump sum or as an annuity with different payment types.
Pension funds work by deducting a portion of your salary and investing it in a pooled pension fund. The contributions grow over time from the returns on these routine investments.
Once you reach the retirement age defined by the pension plan, you are eligible to receive regular payments from your pension. How much pension income you receive depends on your salary, the years of service you put in and the pension plan’s formula.
Most modern pensions are funded by the federal, state or local governments. In the past, about 88% of American workers in the private sector relied on pensions for retirement income. By 2016, the National Public Pension Coalition reported that only 33% of private sector workers had pensions.
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When Can You Sell Your Pension?
You can’t legally sell some types of pensions, including most federal pensions. But if you have a non-federal pension, it may be possible to sell all or some of your future payments.
Typically, you can’t access or sell your pension until you reach retirement age. This is usually age 62 or 65 in most pension plans.
Some smaller plans may allow you to cash out at any age by opting for a lump-sum payout instead of periodic payments. Check your plan’s rules for specifics.
When you reach your plan’s retirement age, a private pension may allow you to choose your payout as either a lump sum or an annuity. There are several different ways to structure your annuity pension payout.
- Single Life Payment
- This type of annuity delivers a monthly payment for the rest of your life. If you die, your beneficiary does not receive payments.
- Single Life with Term Certain
- You will receive monthly payments for a specific number of years. If you die before that time is up, your beneficiaries will receive payments until the time runs out.
- Joint and Survivor Annuities
- Joint and survivor annuities typically cover two people for their combined lifetimes. If you die, your partner continues receiving pension payments until they die.
- Refund Annuities
- Guarantee that a specific amount of money will be paid over the life of the annuity. Even if the recipient dies, the payments will continue to the beneficiary until the full amount is paid out.
Ways Your Pension Payout Can Be Structured
In some cases, once you acquire the rights to your pension income stream, you may be able to sell your annuity payments to a factoring company for a discounted lump sum.
It may make sense to consider selling your pension. Consider whether your pension is eligible to be sold and be aware of the tax implications and penalties of selling before retirement age. Contact a financial professional to help you evaluate whether it is worth selling your pension.
Timothy Li, MBABusiness Finance ManagerTimothy Li, MBA, has dedicated his career to increasing profitability for his clients, including Fortune 500 companies. Timothy currently serves as a business finance manager where he researches ways to increase profitability within the supply chain, logistics and sales departments.
Considerations Before Cashing Out Your Pension
Before cashing out your pension, remember that this is money set aside for your retirement plans. Consider how your choices will affect how much money you will receive for the rest of your life, how much tax liability you will face, and how your decision will affect your partner’s financial future.
Specific considerations include avoiding early withdrawal penalties, life expectancy and your retirement income needs.
Early Withdrawal Penalties
If you are given the opportunity to cash in some or all your pension before retirement you may have to pay a 10% penalty tax if you are not yet 59½.
There are some exceptions such as if you have a permanent disability, you took the lump sum because the pension plan’s participant has died, or you took the payments in regular and equal payments after separating from your job.
Life Expectancy
Taking a lump-sum payment will be less money than if you receive ongoing payments over several years because you are giving up earnings on your money. Consider your estimated life expectancy and your current age before deciding whether to cash in or sell your pension.
Use a life expectancy calculator to estimate your actuarial age.
Retirement Income Needs
You’ll need to identify and create a budget to determine how much money you’ll likely need from your pension. Having the guaranteed income of a monthly pension payment may provide more security to meet those needs than relying on a single lump-sum payment.
Also plan for the unexpected. Health care costs in retirement and long-term care costs can eat up retirement income and savings.
If your income is just enough to cover your expected expenses, pension payments may be a better option. But if your guaranteed income is more than expenses, it’s worth considering a lump sum.
Your Partner’s Benefits
Couples should consider what distribution option is best for them as a couple.
You can structure your pension payments to provide payments to your spouse should something happen to you.
These payments can continue through your spouse’s lifetime — a joint-and-survivor annuity — or for a period of time after you die — a single-life annuity with period certain.
Tax Implications
When debating whether to cash out your pension, understand that the periodic payments option gives you some tax advantages.
Income taxes on annuities are deferred until you withdraw your money — that is, you only pay tax on each payment you receive. But you can only defer taxes on a lump-sum payment if you roll over the lump sum into an IRA.
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Can You Cash Out Other Retirement Accounts?
It’s possible to withdraw money from 401(k), 403(b) and 457(b) retirement plans or from an IRA. But you may face stiff penalties and tax implications.
You’re subject to the IRS 10% penalty tax if you withdraw money from 401(k)s and IRAs before you turn 59 ½.
People with 403(b) plans can withdraw money penalty-free when they retire or separate from service in the year they reach age 55 or any time after that.
People with a 457(b) plan can withdraw money at any age when they separate from service with their employer.
In any case, you have to pay income taxes on the money you withdraw unless it’s a Roth plan. You are also subject to any state income taxes that may apply.
Exceptions for 401(k)s may include hardship withdrawals or taking money out of your plan for medical expenses greater than 10% of your annual adjusted gross income.
Cashing Out Your Pension FAQs
You can’t usually access funds in a pension plan in the United States until reaching the retirement age specified by your plan, usually 62 or 65. But many small pension plans allow the option to receive a lump-sum distribution instead of lifetime payments. These plans can be, in effect, cashed out for their benefit no matter what age you are.
Other retirement plans such as 401(k), 403(b) and 457(b) plans may provide for hardship distributions for unexpected life events. This varies by plan, so discuss your options with your plan administrator.
With a U.S. pension plan, benefits are typically not accessible until you reach your plan’s retirement age. This is typically age 62 or 65. Small plans may allow you to take a lump-sum distribution instead of lifetime payments.
Many traditional pensions — or defined benefit plans — allow no more than a $5,000 lump-sum distribution. But pensions that are cash balance plans will allow you to take a single lump-sum payment.
If you are cashing out a defined contribution plan such as a 401(k), you typically have to pay a penalty tax equal to 10% of your withdrawal if you are younger than 59 ½.
Pension payments, interest and dividends on investments, and annuity payments will not lower your Social Security retirement benefits. However, the Government Pension Offset (GPO) law does affect the Social Security benefits of spouses, widows and widowers who also receive pensions from a federal, state or local government job.
There are five general steps you should take when cashing in your pension:
1. Assess your eligibility. Not all pensions can be cashed out.
2. Review your pension plan’s documents to understand how your plan works and what cash-out options are available.
3. Calculate the present value of your pension both as a lump sum and as payments over your expected life expectancy.
4. Consider the tax implications and penalties of a lump-sum payment.
5. Submit a formal request to your pension plan administrator.
It’s wise to consult with a financial advisor or other professional for personalized guidance throughout the process.
Writer Jerry Brown contributed to this article.
