When you retire, you may have the option of taking the value of your pension, salary reduction, or profit-sharing plan in different ways. For example, you might be able to take your money in a series of regular lifetime payments, generally described as an annuity, or all at once, in what is known as a lump-sum distribution.
If you take the lump sum from a defined benefit pension plan, the employer follows specific regulatory rules to calculate how much you would have received over your estimated lifespan if you'd taken the pension as an annuity and then subtracts the amount the fund estimates it would have earned in interest on that amount during the payout period. In contrast, when you take a lump-sum distribution from a defined contribution plan, such as a salary reduction or profit-sharing plan, you receive the amount that has accumulated in the plan. You may or may not have the option to take a lump-sum distribution from these plans when you change jobs.
You can take a lump-sum distribution as cash, or you can roll over the distribution into an individual retirement account (IRA). If you take the cash, you owe income tax on the full amount of the distribution, and you may owe an additional 10% penalty if you're younger than 59½. If you roll over the lump sum into an IRA, the full amount continues to be tax deferred, and you can postpone paying income tax until you withdraw from the account.