Is an “alternative form of annuity” lump sum payment taxable?
This form of payment currently is available only to employees who have a life-threatening illness or other critical medical condition, and do not have a former spouse entitled to court ordered benefits based on the employee’s federal service. A lump sum payment is made and the annuity is reduced according to actuarial factors.

The lump sum represents a return of the employee’s contributions to the retirement program with interest; only the interest portion is taxable. Taxes can be deferred by having that portion transferred directly to an IRA or other retirement savings plan meeting certain standards.