Should You Rollover Your Pension into an IRA?

Should You Rollover Your Pension into an IRA?

Can You Do a Pension Rollover to an IRA?

The short answer is, yes, most people can roll a pension balance into an individual retirement account. In fact, with many companies choosing to close out their traditional pension plans, it’s encouraged for workers to roll the pension into an IRA or another employer plan like a 401(k). The IRS is extremely keen for retirement savings to stay where they belong – in a protected retirement savings account that cannot be touched until retirement.

There are two caveats: first, the pension must be a “qualified employee plan,” that is, for the exclusive benefit of employees that meets IRS requirements. If you’ve enjoyed tax deferral on your contributions, the plan almost certainly will be a qualified plan. Second, you must have left the company or your employer must be intending to close out the plan in order to perform a rollover. It’s a good idea to verify the plan status with your employer or the plan administrator before initiating the transfer of funds.

Can People Still Work After a Rollover?

Most people wonder whether they can keep working after making their rollover. Overall, people can keep working. However, if the private companies they're working at are closing their pension plan, they can still work there.

On the contrary, if these companies aren't closing their pension plan, people must either make the rollover and stop working with the company or keep working with their current plan.

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Why Would Someone Rollover Their Pension into a Roth/Traditional IRA?

This is a question many people ask their financial advisor. Some people prefer to keep it safe and take monthly distributions from their plan administrator, and others prefer to roll their retirement funds into a traditional or Roth IRA and keep full control over their money.

Overall, a pension is going to pay someone money into their IRA account for the rest of their life. Whether they decide they want a lump sum payout or a monthly annuity, they must follow the rollover rules and the IRS rules.

First, it's important to note that not every pension plan allows people to take a lump-sum distribution plan, such as teachers, who are required to take the monthly annuity. Either way, there are a lot of benefits to rolling over a pension plan into a traditional IRA, and this article is going to outline these benefits below.

An IRA is always going to have more variety of investment options in comparison to defined benefit plans since the latter offers only a selected amount of approved investments. It's vital to keep in mind that an IRA allows people to invest in funds/index funds, bonds, stocks, and many other assets that can protect their future income.

On the other hand, if someone makes a direct rollover transaction to an IRA, they may not have to pay taxes for distribution. This is because traditional IRAs are tax-deferred retirement accounts, meaning people don't have to pay anything until they withdraw the funds. In case someone makes the transaction to a Roth IRA, they may have to pay taxes when they transfer their pension plan. However, people don't have to pay any taxes to make a withdrawal from a Roth account.

A regular pension plan often limits how (and when) people can make a withdrawal. However, IRAs allow people to withdraw their funds with more flexibility if they're planning on doing it before they retire. Overall, people don't have a maximum number of times they can withdraw funds, but they may have to pay income taxes. Still, some exemptions may help some people, such as medical expenses, education expenses, or home purchases.

In essence, people are going to have much better control over their retirement savings if they roll over their pension to an IRA. For an instance, a person who is interested in investing $20,000 of their savings can choose where to open their IRA, enjoy a wider range of investment options, and choose the way in which they want to allocate their assets in their investment portfolio.

It's important to keep in mind that, even if the person changes their job in the future, they can keep their current IRA and save for their retirement. In the case of a regular employer's retirement plan, people would have to stop taking contributions if they leave the job.

Many things can help people if they transfer their pension plans into an IRA, whether they choose a lump sum distribution or the annuity plan. Unfortunately, everything in life has its advantages and disadvantages, meaning there are also some cons people must be aware of if they're looking to adjust their pension plan.

Common questions

What is the difference between a rollover and transfer of assets?

A rollover is when you move funds from one eligible retirement plan to another, such as from a 401(k) to a Rollover IRA. Rollover distributions are reported to the IRS and may be subject to federal income tax withholding. See the question below around direct and indirect rollovers to understand both options and their tax consequences. 

A transfer of assets is when you instruct your retirement account provider to move funds directly between two accounts of the same type, such as from one Traditional IRA to another Traditional IRA. Transfers can take place as often as you like. They are not reported to the IRS because you never take possession of your money.

Are there fees associated with a Schwab Rollover IRA?

There are no fees to open or maintain a Rollover IRA at Schwab. You only pay fees for transactions you make in the account, such as trading stocks, or for investments you hold in the account, such as operating expenses on mutual funds. See the Charles Schwab Pricing Guide for Individual Investors and its amendments for comprehensive details on fees.

What types of retirement plans can I roll over?

Eligible employer-sponsored retirement plans are those that you receive qualifying distributions from, and include 401(k) plans, 403(b) plans, profit-sharing plans, money purchase plans, and Keoghs/Qualified Retirement Plans (QRPs). 

Plans that may not be eligible include employee stock ownership plans (ESOPs) and defined benefit plans. 

You may be allowed to roll over after-tax dollars and governmental 457(b) qualifying distributions. Contact your plan administrator(s) to find out if your particular plan is eligible for rollover.

What is the difference between a direct rollover and an indirect rollover?

With a direct rollover from an employer-sponsored plan to an IRA, the administrator of your plan delivers your distribution directly to the financial provider where your Rollover IRA is held. Since you never actually take possession of your assets, there is no mandatory 20% federal tax withholding. 

With an indirect rollover, you do receive the assets from your employer-sponsored plan, and roll over either all or a portion of the assets into another eligible plan within 60 days of receiving the distribution. Your employer may be required to withhold 20% for federal income tax. However, you can recover the deduction if you roll over the amount you received from your prior employer plus the 20% that was deducted. You will receive the refund in the form of a tax credit when you file your tax return.

What if my employer made my rollover distribution check payable to me, rather than to Schwab?

If your employer sends you a rollover distribution check made payable to you, you can deposit it directly into your Rollover IRA. Be sure to write your Schwab Rollover IRA account number on the check and deposit it within 60 days to avoid taxes and penalties.

Your plan administrator may have withheld 20% for federal income tax. You can recover the deduction if you roll over the amount you received from your prior employer plus the 20% that was deducted. 

Please see IRS Publication 590 or talk with your tax advisor for more details.

I am not sure how to request a rollover from my prior employer. What should I do?

Call a Schwab Rollover Consultant at 866-855-5635 and we will work with your former plan administrator to make sure your retirement savings are rolled over properly. Please talk with your tax advisor for details about your specific situation.

Am I responsible for tracking my pre- and post-tax rollover contribution amounts?

Yes, you are responsible for tracking your tax basis. All rollovers are tax-reportable events on IRS Form 1099-R for the distributed amount and Form 5498 for the contributed (rollover) amount.

Can I make contributions to my Rollover IRA once it is open?

Yes, but if you do, you may not be able to roll the IRA into a new employer-sponsored retirement plan. Different plans determine which assets, if any, will be accepted. If you think you might start a new job in the future, you should check with your new employer regarding their plan’s rules.

Pros of rolling over a Pension into an IRA

Pro: Variety of investment options

An IRA has a wide variety of investment options compared to a pension plan, which limits participants to a select number of approved investments. An IRA allows you to invest in multiple investments such as mutual funds, index funds, stocks, bonds, etc. You can allocate your portfolio depending on the investments you prefer and your risk profile.

Pro: Avoid paying taxes

If you choose to rollover your pension directly to a traditional IRA, you will not pay taxes or penalties on the distribution. A traditional IRA is a tax-deferred retirement account, and it defers payment of taxes until when you withdraw money. However, this is different for a Roth IRA, which is taxed when you rollover your pension funds into the retirement account. Withdrawals from a Roth account are tax-free.

Pro: Withdrawal flexibility

Generally, pension plans limit how and when a participant can make a withdrawal. When you rollover your pension plan into an IRA, you have greater flexibility if you decide to withdraw funds before retirement. IRAs do not limit the number of times you can withdraw funds, but you will be required to pay income taxes and penalties on the withdrawal amount. Also, there are certain exemptions such as qualifying education expenses, medical expenses, and first-time home purchases that allow participants to make a penalty-free withdrawal from an ITA.

Pro: Greater Control

An IRA gives you greater control over your retirement savings. You can decide where to open an IRA, choose investment options based on your risk profile, and determine the asset allocation in your portfolio. If you switch jobs in the future, you can still retain your IRA account and continue saving for your retirement. This sidesteps key limitations of a pension plan where you are just a participant, and leaving your job means you won’t make further contributions to the retirement plan.

Is my retirement plan required to allow transfer of any amounts eligible for a distribution?

If you receive an eligible rollover distribution from your plan of $200 or more, your plan administrator must provide you with a notice informing you of your rights to roll over or transfer the distribution and must facilitate a direct transfer to another plan or IRA.

Another Pension Withdrawal Option: Lump Sum Payout

If you are 55 years of age or older when you leave the company or the plan is closed, you are permitted to take the company pension as a lump sum distribution without triggering the 10 percent premature distribution penalty. You will, however, pay ordinary income tax on the distribution in the year you take the money. This rule is unique to pension plans. With 401(k)s and IRAs, for example, you’re liable to pay a 10 percent tax penalty on distributions taken before age 59 1/2. So, if you roll the money over, you’ll lose the ability to take a penalty-free withdrawal until you reach that later age.

Some companies will allow you to split the rollover, taking some of the plan balance as a lump sum now and rolling over the rest. You’ll get a check for the partial rollover so keep in mind that 20 percent will be withheld for federal taxes.

When should I roll over?

You have 60 days from the date you receive an IRA or retirement plan distribution to roll it over to another plan or IRA. The IRS may waive the 60-day rollover requirement in certain situations if you missed the deadline because of circumstances beyond your control.

Can I roll over my pension into a Roth individual retirement account (Roth IRA)?

If the rules on your employer’s defined-benefit pension plan allow it, you may be able to take a lump-sum distribution from the plan when you leave your job or retire. You then would have the option of rolling it over into a Roth individual retirement account (Roth IRA).

Rick’s Insights

  • Company retirement plans are required to withhold 20% of distri­b­u­tions made directly to a person for income taxes.
  • Distri­b­u­tions from a company plan are not subject to the 10% early withdrawal penalty if you are age 55 and separated from service.
  • Net unrealized appre­ci­ation (NUA) is a compli­cated strategy that may offer signif­icant tax savings if you hold company stock in your employer’s plan.

New Job, New Plan

Putting all your retirement savings into one 401(k) plan has its advantages. For example, it will make it easier for you to track your assets’ performance.

But you should evaluate your new employer’s plan before deciding to roll your assets over. Make sure the new plan has plenty of investment choices and includes the investment options you prefer. Also check to make sure that accompanying fees aren’t too high. If you’re unhappy with the options provided by your new employer’s 401(k), you can always consider your other options, including a rollover into an IRA.

Remember, too, that even if your new employer accepts rollovers, you may have to wait until the next enrollment period, or sometimes until you’ve been on the job a full year, to move your assets.

What to Consider Before a Pension Rollover to an IRA

According to the IRS, you can roll over a qualified pension plan to any type of retirement account. But, even if your rollover meets the considerations of being a qualified plan and if you are leaving the company or the company is closing its pension plan, there are other factors you should consider when deciding whether to roll over your pension plan to an IRA.

First, you generally have a wider variety of investment options in an IRA than in a company pension plan. You can choose your own investments, taking into consideration your individual risk tolerance, investment goals and time horizon. Types of investments would include stocks, bonds and mutual funds, but you’re not limited to just those.

When do you plan to retire? Under a company pension plan, you can take a distribution from your retirement account at age 55. If you do a pension rollover to an IRA, you will have to wait until you are 59.5 to take a penalty-free distribution. The penalty is 10% if you take a distribution before 59.5. There are exceptions to this rule. If you have qualified education expenses, medical expenses or if you are a first-time homebuyer, you may be able to make a withdrawal without a penalty

You can avoid paying taxes on the rollover if your pension is going to a traditional IRA. You only pay taxes when you make a withdrawal if the withdrawal is going to the traditional IRA. This is different for a Roth IRA. If you set up a Roth IRA, you pay taxes when the pension is rolled over.

Many traditional pension plans allow you to take out a loan if you need to for up to 50% of the value of your pension. This option is not available when you roll over your pension into an IRA.

Funds in a traditional pension plan are safe from creditors in the event of financial hardship or even bankruptcy. Your IRA, or at least a portion of it, can be seized in the case of bankruptcy. Check your individual state governments to see what their rules are regarding how much of your IRA can be confiscated.

Does the company pension plan include the distribution of the company’s stock? Some plans include company stock and some don’t. If your plan does include company stock, you may want to wait until you are retired and in a lower tax bracket, to take a distribution. If you take this distribution of company stock before age 59.5, you pay taxes on your distribution at the ordinary tax rate plus a 10% penalty. If you are 59.5 years of age when you take this distribution, you won’t pay the 10% penalty. You will pay taxes at your ordinary rate on the cost basis and long-term capital gains taxes on the rest of the appreciation when the stock is sold.

Indirect Rollovers

You can handle a rollover yourself by withdrawing money from your account and depositing it in your new employer’s plan or an IRA. You may opt for an indirect rollover to take advantage of a short-term loan if you’re temporarily between jobs or you’re waiting to close on your old home to make the down payment on a new one.

Caution: Opting for an indirect rollover as a short-term loan should be a financial last resort, since you’ll face early withdrawal penalties unless you repay the loan within 60 days. The IRS has a self-certification procedure if you inadvertently miss the 60-day time limit.

When you indirectly roll over a 401(k), your employer gives you a check for the value of your account, minus 20 percent withholding. The IRS requires your employer to take out that 20 percent in case you decide to keep the money rather than roll it into another account. Even though that amount isn’t included in the check you receive, you must provide it from another source if you want the full amount of your rollover to remain tax deferred. If you complete the full rollover within the time limit, the withholding will be returned to you when you file your tax return for the year. However, if you do decide to keep the money, the withholding will go towards the taxes you’ll owe on the early distribution.

Any pretax contributions and all earnings that you don’t deposit within this 60 day window are considered withdrawals and are taxable. You may also be vulnerable to an additional 10% tax penalty if you are younger than 59½.

The Bottom Line

If you have a traditional pension at work, you may have the option of taking a lump sum when you change jobs or retire. You can then reinvest that money. If you roll it over into a traditional IRA, you won’t have to pay any taxes until you make withdrawals. If you choose a Roth IRA, you’ll have to pay tax on the money up front, but your future withdrawals can be tax free. If you decide to go with the Roth, you can reduce the tax impact by depositing the money first in a traditional IRA and converting it into a Roth IRA over a series of years.

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