Is a federal retiree lump-sum payment taxable?

What the lump sum is

The alternative annuity option lets certain retirees take a lump sum equal to their contributions plus a reduced monthly annuity. The publication says you are eligible only if you are retiring but not on disability, you have a life-threatening illness or other critical medical condition, and you have no former spouse entitled to court-ordered benefits based on your service. This is not the same thing as a refund of contributions when you leave without an immediate annuity, which has its own treatment, and it is not a general lump sum from a private pension.

How the tax-free and taxable parts are split

The lump-sum payment generally has a tax-free part, which represents part of your cost, and a taxable part, which represents part of the earnings on the contract. Worksheet B has five lines. Line 1 is the lump-sum credit, which is generally the same as the payment (your total contributions) and can include deemed deposits and redeposits that OPM advanced so you are credited with service. Line 2 is the present value of your annuity contract, figured with IRS actuarial tables. Line 3 divides line 1 by line 2. Line 4, the tax-free amount, is line 1 times line 3. Line 5, the taxable amount, is line 1 minus line 4, and it is also your net cost for the reduced annuity.

The deemed deposits and redeposits are taxable in the year of retirement, so your taxable amount can be larger than the cash you actually receive. If you want to know the present value of your contract, the publication gives an IRS actuarial group address to write to.

Worked example from the publication

David Brown retired in 2025, one month after his 55th birthday, with $31,000 in contributions, and chose a $31,000 lump sum. The present value of his annuity contract is $155,000. Line 3 is $31,000 ÷ $155,000 = 0.20, so the tax-free amount is $31,000 × 0.20 = $6,200, and the taxable amount is $24,800. That $24,800 goes into the Form 1040 line 5b total and also becomes his net cost on Worksheet A, line 2.

He then received 10 payments of $1,200, or $12,000. Worksheet A line 3 is 360 (age 55 or under, annuity starting after November 18, 1996), so line 4 is $24,800 ÷ 360 = $68.89, line 5 is $688.90, and the taxable part of his annuity is $11,311.10 with $24,111.10 of cost still to recover. The tax-free part of the lump sum is not added to the amounts recovered on line 6.

Rollover, withholding and extra taxes

You include the taxable part in income for the year unless you roll it over into another qualified plan or an IRA. If you do not have OPM transfer the taxable amount in a direct rollover, 20% is withheld. OPM can roll over only up to the amount of the lump-sum payment, so to defer tax on a taxable amount that is larger, you must add funds from another source. The taxable part is not a lump-sum distribution eligible for capital gain treatment or the 10-year tax option. It may also face the 10% additional tax on early distributions if you separate from service before the calendar year in which you reach 55. David was already 55, so that did not arise for him.

How to report it

Add the actual or deemed payment of your lump-sum credit to the total on Form 1040 line 5a. Add the taxable amount to line 5b unless you roll it over to a traditional IRA or a qualified retirement plan. Keep the completed worksheets: the reduced annuity uses Worksheet A with the net cost, and the same tax-free monthly amount is reused each year. Different rules apply if the annuity starting date was before November 19, 1996. If you were reemployed after taking this option, use your total contributions if the Form CSA 1099-R shows only part of them.

Sources

• IRS Publication 721, Tax Guide to U.S. Civil Service Retirement Benefits (2025): Rules for Retirees (Part II): Alternative Annuity Option; Lump-Sum Payment (Worksheet B and the David Brown example); Reduced Annuity; Annuity starting date before November 19, 1996; Refund of Contributions (Part I). Read November 2, 2026.

Edition read: Publication 721 (2025), for use in preparing 2025 returns. Dollar limits and dates in this publication are for 2025; check the current publication and form instructions for your tax year. This page summarizes the publication and does not replace it.