Can You Take Money Out of a Pension?
Withdrawing from your pension involves more than just a request. Learn the crucial distinctions between plans and the timing that shapes your financial outcome.
It is possible to take money from a pension, but the rules are specific and carry financial consequences. Your ability to withdraw funds, the available methods, and the tax implications depend on the type of pension plan, your age, and employment status.
Understanding Your Pension Plan Type
Pension plans fall into two main categories: defined benefit plans and defined contribution plans. Understanding which type you have is the first step in determining your withdrawal options. Each is governed by different rules under the Employee Retirement Income Security Act (ERISA), which sets the standards for private industry pension plans.
A defined benefit (DB) plan is a traditional pension that promises a specific monthly payment in retirement. The benefit is calculated using a formula based on your salary history, age, and years of service. The employer funds the plan and assumes all investment risk. The Pension Benefit Guaranty Corporation (PBGC), a federal agency, insures most private defined benefit plans.
A defined contribution (DC) plan does not promise a specific benefit amount. Instead, you and your employer contribute to an individual account, such as a 401(k) or 403(b). The final amount you receive depends on the total contributions and investment performance, meaning you bear the investment risk.
Withdrawal Options Before Retirement Age
Accessing pension funds before the plan’s normal retirement age, often 59½, is possible under certain circumstances but usually has financial drawbacks. One common scenario for early withdrawal is leaving your job. Your ability to take money depends on your vesting status, which is the length of time you must work to have a right to the pension benefits. Vesting schedules often require around five years of service.
If you are fully vested when you leave, you are entitled to your benefit. For DC plans, you can take a lump-sum distribution, though this has tax consequences detailed later. Alternatively, you can roll the funds into an Individual Retirement Account (IRA) or a new employer’s plan to maintain tax-deferred status.
Some DC plans, like 401(k)s, permit hardship withdrawals for an “immediate and heavy financial need,” and the amount cannot exceed that need. Qualifying reasons include certain medical bills, costs to purchase a primary home, payments to prevent eviction, and some educational expenses. A hardship withdrawal does not automatically grant an exemption from the 10% early withdrawal penalty; the reason must also qualify under a specific IRS exception.
Some DC plans allow you to take loans against your account balance, an option not available for DB plans. You can borrow up to 50% of your vested balance, with a maximum of $50,000. These loans must be repaid with interest, over a period of up to five years. If you leave your job with an outstanding loan, you may have to repay it quickly to avoid it being treated as a taxable distribution.
Withdrawal Options at Retirement Age
Upon reaching your plan’s retirement age, you gain access to distribution options without early withdrawal penalties. The choices depend on your plan type but involve receiving your money as a single payment or a stream of payments.
A lump-sum payment allows you to receive the entire value of your pension at once. For a DC plan, this is your account balance. For a DB plan, the lump sum is the calculated present value of your future promised payments. Taking a lump sum provides immediate access to the funds but also transfers the responsibility of managing that money to you.
The alternative to a lump sum is an annuity, which provides a guaranteed income stream and is the default for most DB plans. A single-life annuity provides payments for the retiree’s life and stops upon their death. A joint and survivor annuity provides payments for the retiree’s life and continues to the surviving spouse, often at a reduced amount.
Federal law requires a married participant to choose a joint and survivor annuity unless their spouse provides written consent to waive that right. Another option is a period certain annuity, which guarantees payments for a set number of years. If the retiree dies before the period ends, a beneficiary receives the remaining payments.
Tax Implications and Penalties
Distributions from pre-tax pension plans are subject to taxation. The money you withdraw is treated as ordinary income for that tax year and is added to your other income. This amount is then taxed at your applicable federal and state income tax rates. A large lump-sum payment can push you into a higher tax bracket for that year.
Withdrawals taken before age 59½ are also subject to a 10% additional tax, known as the early withdrawal penalty. This penalty is applied to the taxable portion of the distribution on top of your regular income tax. For example, a $20,000 early withdrawal in the 22% federal tax bracket would result in $4,400 in income tax plus a $2,000 penalty.
The IRS allows several exceptions to the 10% early withdrawal penalty for those under age 59½. These include:
- Distributions made due to total and permanent disability or a terminal illness.
- Withdrawals after leaving your job in or after the year you turn 55.
- Payments for unreimbursed medical expenses that exceed 7.5% of your adjusted gross income.
- Distributions to an alternate payee under a Qualified Domestic Relations Order (QDRO).
- Withdrawals taken by a beneficiary after the plan participant’s death.
- Funds for personal or family emergency expenses up to $1,000.
- Withdrawals by victims of domestic abuse, up to the lesser of $10,000 or 50% of the account balance.
The Process for Requesting a Withdrawal
The first step is to contact the plan administrator. You can get their contact information from the human resources department of your current or former employer.
The plan administrator will provide the necessary distribution request forms. This paperwork requires personal details and your formal selection of a distribution option, such as a lump sum or a specific annuity. The package will also include tax withholding forms, like the Form W-4P, to direct how much federal income tax to withhold.
If you are married and choose an option other than a qualified joint and survivor annuity, your spouse must sign a notarized consent form. After completing the paperwork, you will submit it to the administrator by mail or through an online portal.
Processing times vary. A lump-sum payment may take several weeks, while annuity payments depend on the plan’s schedule. Online requests are often processed more quickly than paper submissions.