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Pension Issues: Lump-Sum Distributions and Retirement Income Security

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Publication Date: January 2009

Publisher(s): Library of Congress. Congressional Research Service

Series: RL30496

Topic: Banking and finance (Personal finance and saving)

Abstract:

Slightly fewer than half of all workers age 21 and older participated in an employer-sponsored retirement plan in 2003, but not all of these workers will receive a pension or retirement annuity from the jobs they now hold. Many will receive a "lump-sum distribution" from their retirement plan when they change jobs. A typical 25-year-old today will work for seven or more employers before reaching age 65, and could receive several distributions before reaching retirement age.

Lump-sum distributions allow workers to re-invest their retirement assets so that they will continue to grow until retirement. However, many recipients of lump-sum distributions use all or part of the distribution for current consumption rather than depositing the funds into an individual retirement account (IRA) or another retirement plan. To encourage individuals to "roll over" these distributions into another retirement plan, Congress in 1986 enacted a 10% excise tax on preretirement pension distributions that are not rolled over. In 1992, Congress required employers to withhold for income tax payment 20% of distributions that are paid to recipients rather than rolled over into another retirement plan. In 2001, Congress required that, unless directed otherwise by the participant, the plan sponsor must deposit distributions of $1,000 or more into an individual retirement account.

According to data collected by the Census Bureau, 51.8 million workers age 21 or older participated in retirement plans that offered a lump-sum distribution as a payment option in 2003. This represented 84.8% of the 61.1 million workers who were covered by a pension, profit-sharing, or retirement savings plan in 2003. Approximately 16.0 million people reported that they had received at least one lumpsum distribution at some time in their lives. The average (mean) value of these distributions was $21,900 and the median value was $6,000. The typical recipient was between 37 and 40 years old at the time of the distribution. Thus, most recipients of lump-sum distributions were more than 20 years away from retirement.

Of survey respondents who reported that they had received at least one lump-sum distribution, 44% said that they had rolled over the entire amount of the most recent distribution into an IRA or other retirement plan, accounting for 67.2% of the dollars distributed as lump sums. Another 40% of recipients said that they had saved at least part of the distribution in some other way. Of those who reported receiving a distribution after 1992, 47% said that they had rolled over the entire amount into another plan, accounting for 72% of the dollars distributed as lump-sums. Another 38% of this group said that they had saved at least part of the distribution.

Lump-sum distributions that are spent rather saved can reduce future retirement income. If the lump-sum distributions received through 2002 that were not rolled over had instead been rolled over into accounts that grew at the same historical rate as the Standard & Poor's 500 Index, they would have had a median value of $7,214 by 2003. For the typical recipient, if this amount were to remain invested, it would grow to an estimated value of $31,100 by age 65, which would be sufficient to purchase a level, single-life annuity that would pay $225 in monthly income.