Rollover IRA notes
Private sector employers that once offered workers traditional pensions, typically defined benefit plans, have been encouraging people to roll over their pensions into tax-advantaged plans like individual retirement accounts (IRA) and 401(k)s. If you’re considering such a move, it’s important to understand your options, the pros and cons of each option and the tax-related rules about such a move. Before you do anything, though, consider working with a financial advisor who can help you make the best choices.
During the 1980s, 60% of private-sector companies offered their workers traditional pension plans, which were usually defined benefit plans. As the years have passed and employees stopped staying with the same company for life, the defined benefit plan is going the way of the dinosaur. Today, only 4% of private companies offer defined benefit plans.
As private-sector companies have discontinued their traditional pension plans, they have encouraged workers to launch a pension rollover to an IRA. Some have replaced the defined benefit plan with a 401(k), a defined contribution plan. They have encouraged their workers to either roll over their pension money to the new 401(k) or initiate a pension rollover to an IRA.
Defined Benefit Pension Rollover to an IRA: How It’s Possible
The short answer to this question is yes or more accurately, usually. Some states have switched from defined benefit pensions to 401(k) plans for their public school teachers and do not allow a pension rollover to an IRA. However, for most people this type of pension rollover is possible and often encouraged by their employer, particularly if they are closing out their defined benefit plan.
Two conditions must be met for you to roll over your pension to an IRA. The first is that the pension plan you are currently under must be a “qualified employee plan” that conforms to Internal Revenue Service (IRS) rules. If your contributions to the plan have been tax-deferred, then the chance is good that it is. The second condition is that you must be leaving the company, through either retirement or other circumstance, or your company must be closing its pension plan. To be safe, contact your plan administrator before you initiate any transfer of funds.
What to Consider Before a Pension Rollover to an IRA
Book entitled “Retirement Plan”
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.
Can You Still Work?
Yes, you can still work. But remember that one of the conditions of rolling a pension over into an IRA is that if the company is closing its pension plan, you can still work there. But if it is not, then you can’t roll over your IRA and keep your employment with your current company. You could retire and embark on an encore career or work in the gig economy.
The Bottom Line
If your company is closing its defined benefit pension plan, you have to decide whether or not to initiate a pension rollover to an IRA. The first consideration is whether you want a monthly annuity or a lump sum. After you make that decision, you have to follow the rules for the rollover. Next, consider the other mitigating factors that should be a part of your decision-making process. Last, if you decide to roll over your pension to an IRA, follow the IRS rules to the letter so you will have no tax liability. It should be a tax-neutral event.
Tips on Retirement Planning
If you have a defined benefit plan and want to roll over your retirement funds to an IRA, you must follow the rules to keep from incurring unnecessary tax liability. There are also more factors you should consider. Use the SmartAsset tax return calculator to see that a rollover should be a tax-neutral financial event as long as you follow the rules and do it properly.
Tax and retirement issues are complex, especially when you’re thinking of rolling a pension into an IRA or 401(k). It would be wise to check with a financial advisor before doing anything. Finding a financial advisor doesn’t have to be hard. Use SmartAsset’s financial advisor matching tool to find an advisor to assist you. It only takes a few minutes. If you’re ready, get started now.
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