Forty-seven percent of all workers aged 21 and older participated in employer-sponsored retirement plans in 2006, but not all of these workers will receive a pension or other income from these plans when they retire. Some will instead 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 age 65, and could receive several such distributions before reaching retirement age.
In most cases, a lump-sum distribution from a retirement plan can be “rolled over” into an individual retirement account (IRA) or another employer’s plan so that it will be preserved until the worker reaches retirement age. However, many recipients of lump-sum distributions use all or part of their distributions for current consumption rather than depositing the funds into another retirement plan. To discourage individuals from spending their savings before retirement, regular income taxes and a 10% additional tax are levied on most pension distributions received before age 59½ that are not rolled over into another retirement account. In addition, employers are required to withhold for income tax purposes 20% of distributions that are paid directly to recipients. Although federal law allows employers to “cash out” accrued pension benefits of less than $5,000 without obtaining the employee’s consent, employers must deposit distributions of $1,000 or more into an individual retirement account unless they are directed to do otherwise by the recipient.
According to data collected by the Census Bureau in 2006, 16.2 million people had up to that time received at least one lump-sum distribution from a retirement plan at some point in their lives. Most of them (13.9 million, or 86%) had received their most recent distribution between 1980 and 2006 and before they had reached age 60. Among this group, the average (mean) value of the most recent distribution they received (measured in 2006 dollars) was $26,845. The median value was $8,864. The typical recipient was 37 years old at the time of the distribution. Thus, most recipients of lump-sum distributions were 25 or more years away from retirement.
Of survey respondents who reported that they had received at least one lump-sum distribution, 45% said that they had rolled over the entire amount of the most recent distribution into an IRA or other retirement plan, accounting for 70% of the dollars distributed as lump sums. Another 41% of recipients said that they had saved at least part of the distribution in some way. Of those who reported that they received their most recent distribution between 1990 and 1999, 47% said that they had rolled over the entire amount into another plan, accounting for 71% of the dollars distributed as lump-sums. Of those who reported that they received their most recent distribution between 2000 and 2006, 46% said that they had rolled over the entire amount into another plan, accounting for 73% of the dollars distributed as lump-sums.
Lump-sum distributions that are spent rather than saved can reduce future retirement income. If the lump-sum distributions received between 1980 and 2006 that were not rolled over had instead been invested in retirement accounts that earned the average annual rate of return on AAA-rated corporate bonds, they would have grown to a median value of $8,800 by 2006. In that year, the median age of those who had not rolled over their distributions was 44. If this amount were to remain invested until the recipient reached age 65 and earned an average annual rate of return of 6%, it would grow to a value of $29,900. With this amount, a 65 year-old man could at current interest rates purchase a level, single-life annuity that would pay $220 in monthly income for life. The Congressional Research Service has updated its report titled “Pension Issues: Lump-Sum Distributions and Retirement Income Security” to include new data from the Census Bureau’s Survey of Income and Program Participation (SIPP).