How do You Calculate Tax on a Lump Sum Payment?

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Understanding Tax on Lump Sum Payments

When you receive a lump sum payment, particularly from a qualified retirement account, there are several tax implications to consider. Here’s how to calculate the taxes:

  1. Federal Income Taxes: Determine your tax bracket based on your total income, including the lump sum. Apply this percentage to the lump sum to estimate the federal tax.
  2. State Income Taxes: Similar to federal taxes, apply your state’s income tax rate to the lump sum. This varies by state.
  3. Early Withdrawal Penalty: If you’re under 59.5 years and withdrawing from a qualified retirement account, add a 10% penalty to the taxable amount.

Using Deferred Annuity with GLWB

A more efficient option to manage taxes on a lump sum, especially from retirement accounts, is using a deferred annuity with a Guaranteed Lifetime Withdrawal Benefit (GLWB).

  • Spreads Taxes Over Years: This approach defers the tax liability, spreading it over several years instead of incurring a large tax bill in one year.
  • Guaranteed Income for Life: GLWB ensures a steady stream of income throughout your lifetime.
  • Lump Sum Death Benefit: Provides a lump sum to your beneficiaries upon your death.

Example Calculation

Suppose you receive a $50,000 lump sum from a retirement account at age 57. Assume you’re in a 22% federal tax bracket and your state tax rate is 5%.

  1. Federal Tax: $50,000 x 22% = $11,000
  2. State Tax: $50,000 x 5% = $2,500
  3. Early Withdrawal Penalty: $50,000 x 10% = $5,000
  4. Total Tax and Penalty: $11,000 (Federal) + $2,500 (State) + $5,000 (Penalty) = $18,500

Conclusion

Calculating tax on a lump sum requires considering federal and state taxes and any penalties for early withdrawal from retirement accounts. Opting for a deferred annuity with GLWB can be a tax-efficient strategy, providing lifelong income and tax spread. The total tax impact will depend on your specific tax bracket and state tax rates.

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Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Shawn Plummer is a Chartered Retirement Planning Counselor, insurance agent, and annuity broker with over 14 years of first-hand experience with annuities and insurance. Since beginning his journey in 2009, he has been pivotal in selling and educating about annuities and insurance products. Still, he has also played an instrumental role in training financial advisors for a prestigious Fortune Global 500 insurance company, Allianz. His insights and expertise have made him a sought-after voice in the industry, leading to features in renowned publications such as Time Magazine, Bloomberg, Entrepreneur, Yahoo! Finance, MSN, SmartAsset, The Simple Dollar, U.S. News and World Report, Women’s Health Magazine, and many more. Shawn’s driving ambition? To simplify retirement planning, he ensures his clients understand their choices and secure the best insurance coverage at unbeatable rates.

The Annuity Expert is an independent online insurance agency servicing consumers across the United States. The goal is to help you take the guesswork out of retirement planning and find the best insurance coverage at the cheapest rates

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