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You can avoid current tax on some or all of your lump-sum pension distribution by rolling it over into an IRA account.
You'll need to make the rollover within 60 days of receiving the lump sum, and you cannot revoke this decision once you make it.
If you make a direct, trustee-to-trustee rollover from your retirement plan to the IRA sponsor, there will be no income tax withholding on your lump-sum payment.
However, if you accept the lump sum in cash with the intention of rolling it over within 60 days, the retirement plan sponsor must withhold 20 percent of the payment for income taxes. In order to avoid all taxes on your lump sum, you will need to roll over 100 percent of the amount, which means that you will have to find some other source (perhaps even a loan) to temporarily replace the 20 percent that was sent to the IRS. Then, when you get your tax refund for the year, you can replenish the other source or repay the loan.
If you do roll over a lump sum you received in 2011, you will receive Form 1099-R from the plan sponsor that shows the amount paid to you in Box 1. Report the total amount on Line 15a of Form 1040, or 11a of Form 1040A. Report any amount that was not rolled over on Line 15b or Line 11b (if you rolled over the entire amount, enter a zero on Line 15b or 11b). You will also need to write the word "rollover" in the margin of your tax return, next to Line 15 or 11.
If you don't roll over the entire amount and you are under age 59-1/2, you may have to pay a 10 percent premature distribution tax on the amounts you took in cash.