Is a lump-sum pension payment taxable?

The headline rule

The 2025 edition of Publication 575 is blunt about lump sums. For individuals born on or after January 2, 1936, lump-sum distributions are taxed as ordinary income unless properly rolled over into an IRA or another qualified plan. These individuals do not qualify for 10-year averaging or capital gain treatment under section 402(d). The publication points anyone born before January 2, 1936 to the 2024 edition for the older special rules. An exception exists for net unrealized appreciation in employer stock, covered below.

What counts as a lump-sum distribution

For the employer-securities rule, the publication defines a lump-sum distribution as the payment of a participant’s entire balance, within a single tax year, from all of the employer’s qualified plans of one kind (pension, profit-sharing or stock bonus) and only if it is paid because the participant died, after age 59½, because an employee separated from service, or after a self-employed person became totally and permanently disabled. A partial withdrawal is not a lump-sum distribution for this purpose; it is an ordinary nonperiodic payment.

The taxable and tax-free parts

The taxable part of a lump-sum distribution is the employer’s contributions and the income earned on your account. You recover your cost tax free. Cost is the total of the participant’s nondeductible contributions, the taxable cost of any life insurance contract distributed, employer contributions that were taxable to the participant, and repayments of taxable loans, reduced by amounts previously distributed tax free.

When a payment comes from a qualified plan before the annuity starting date and is not the whole account, the publication gives a formula: amount received × cost of contract ÷ account balance = tax-free amount. Ann Brown receives $50,000 from a plan where she has $10,000 of cost and a $100,000 balance, so $5,000 is tax free and $45,000 is taxable. Only amounts you have a nonforfeitable right to count in the balance. Enter your numbers above to apply the same formula.

Rollovers and the 20% withholding

A direct rollover to a qualified plan or a traditional IRA defers the tax and avoids withholding. If the plan pays you instead, 20% is withheld from an eligible rollover distribution and you cannot opt out. You then have 60 days to roll over the money, and to defer tax on the whole distribution you must replace the withheld 20% from other funds. If you roll over only part of the lump sum, the part you keep is ordinary income, and if you are under age 59½ it may also face the 10% additional tax. Rolling to a Roth IRA follows the Roth conversion rules.

Employer stock and net unrealized appreciation

If part of the distribution is employer securities, tax on the net unrealized appreciation (NUA), the increase in value while the securities were in the trust, is generally deferred until you sell, shown in box 6 of Form 1099-R. You may instead choose to include the NUA in income at distribution, but then the full value of the securities is taxed as ordinary income that year and none of it gets capital gain treatment under the NUA rules.

Losses and special cases

If a lump-sum distribution is less than the participant’s cost, you may be able to claim a loss, but only if the distribution is entirely in cash or worthless securities; the loss is the cost minus the cash. For tax years after 2017, miscellaneous itemized deductions subject to the 2%-of-AGI limit are suspended, so the loss deduction may not be usable. A loan treated as a deemed distribution is not an eligible rollover distribution and does not qualify for the old 10-year option.

Worked example

A 58-year-old who has left her employer and requests a $60,000 lump sum from a plan where $12,000 is her after-tax cost and the vested balance is $120,000. If she asks for a check, 20%, or $12,000, is withheld and she receives $48,000. If she deposits only that $48,000 into an IRA within the time allowed, the $12,000 not rolled over is income for the year, and she would have to find $12,000 elsewhere to roll over everything. A direct rollover of the full $60,000 makes nothing taxable now and has no withholding. For a partial payment that is not rolled over, the cost formula above gives the tax-free share, $6,000 here ($60,000 × $12,000 ÷ $120,000), and the calculator shows the same split. The 10% additional tax is a separate question; she separated in or after the year she turned 55, which is one of the listed exceptions.

Sources

• IRS Publication 575, Pension and Annuity Income (2025): Lump-Sum Distributions; Distribution Before Annuity Starting Date From a Qualified Plan; Rollovers (partial rollovers; withholding); Distributions of employer securities. Read November 2, 2026.

Edition read: Publication 575 (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.