Lump-Sum Distribution

A lump sum distribution is a one-time payment for an entire amount due, rather than payments broken into smaller installments. In certain cases, lump-sum distributions receive special tax treatment.

Two examples of lump sum distributions are a commission check and a pension plan distribution, following a pensioner’s death.

In general, distributions from qualified plans are treated as lump sums if the following requirements are met if the total plan balance is distributed over the same tax year and if the distribution is made as a result of the employee:

• Attaining age 59.5
• Being deceased (applicable to beneficiaries)
• Separating from service (not applicable to self-employed individuals but applies to their common-law employees)
• Being disabled (applicable only to self-employed individuals)

The distribution occurs after five years of participation (this requirement is waived for beneficiaries).

If a pension plan owner passes away, a lump sum distribution will often transfer to a beneficiary or beneficiaries. These can be relatives, close acquaintances, or even institutions such as charities. Beneficiaries can be revocable or irrevocable, have discretionary powers (or not).

Qualified plans generally fall into two categories: defined benefit and defined contribution. Defined benefit plans give employees a guaranteed payout; this places the risk on the employer to save and invest properly to meet plan liabilities. For employees in a defined contribution plan, the amount they receive in retirement depends on how well they save and invest on their own behalf during their working years. A 401(k) is the most popular example of a defined contribution plan.

Other examples of qualified plans include:

• Profit-sharing plans
• 403(b) plans
• 457 plans
• Money purchase plans
• Target benefit plans
• Employee stock ownership (ESOP) plans
• Keogh (HR-10)
• Simplified Employee Pension (SEP)
• Savings Incentive Match Plan for Employees (SIMPLE)

The Internal Revenue Service (IRS) provides a comprehensive guide to common qualified plan requirements. This guide breaks down each plan and who they best suit, draws comparisons among them, and notes risks or concerns for potential or current investors.

Commission checks are another impetus for lump sum payments. Commission checks apply to roles mainly in sales and marketing either as sole earnings or in addition to a base salary. Employers often use sales commissions to incentivize workers to produce more value. Several major types of commission checks include a base salary and commission, straight commission, draw against commission, and residual commission.