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7 min read

Here are the Rules When Rolling Over Your Pension to an IRA

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If you have a traditional pension plan, you may have the option of taking a lump sum disbursement when you leave your job or retire. One of your options might be to roll the money into an IRA account. Here are some of the things you should think about when deciding whether rolling your pension over into an IRA is the right move for you.

Rolling a Pension Into an IRA: An Overview

When you roll your pension over into an IRA, you move the money you have in your pension plan into an IRA at a broker of your choice. If you follow the IRS rules, there are generally no taxes or penalties for making this move.

There are two types of pensions to be aware of: defined benefit and defined contribution. Which type of pension plan you have determines how the rollover works.

Defined Contribution Plans

With a defined contribution plan, you put in a fixed amount of money per month. For example, you might tell your employer to put 10% of your paycheck into your plan.

The most common type of defined contribution plan is 401(k)s. Some small employers also use a Simplified Employee Pension or SEP IRA.

When you roll over a defined contribution pension, all the money you contributed plus your investment gains is yours to roll over. If you contributed $30,000 and your account is currently worth $50,000, you can roll $50,000 into your IRA.

Employer contributions work the same way once you've met the vesting period. Vesting rules vary by employer. For example, if your employer says you lose employer contributions if you leave before three years, you can only include the employer contributions in your rollover if you were at the job for longer than three years.

Defined Benefit Plans

Defined benefit plans are when your employer pays you a fixed amount in retirement. For example, you might be able to retire with a benefit of 75% of your salary once you reach 25 years with the company and age 55. These types of plans are most common in government jobs.

You can also roll over a defined benefit plan, but it's more complicated than a defined contribution plan. Your employer has to allow early pension plan withdrawals. They also have to have a rule that says how much you get if you cash out your pension plan early.

If your employer allows you to cash in your pension early, you will usually receive less than you would have in retirement. For example, if your retirement pension would be worth $500,000 in retirement, you might only be able to cash in and roll over $200,000.

Benefits of Rolling a Pension Into an IRA


There are several benefits of rolling a pension into an IRA.

Save on Income Taxes

There are two main tax benefits to rolling a pension into an IRA. First, the rollover is tax-free if you properly deposit funds from a qualified pension into a Traditional IRA.

Second, you have better control over when you pay taxes on distributions. Once your pension starts paying, often around age 55, you have to pay taxes on the pension payments. If you move the money into an IRA, you don't have to take distributions or pay taxes until you have to take the required minimum distributions (usually around age 72).

Another tax option is to convert your funds into a Roth IRA. You pay taxes on a Roth conversion, but you get to pick when you do the conversion. A common move is to leave your money in a traditional IRA to start, then convert it to a Roth IRA in a year you're in a low tax bracket.

Reduce the Risk of Losing Your Pension

There have been many cases where retirees lost all or part of their pensions when their former employer entered bankruptcy or had other financial problems. If you roll your pension into an IRA, you no longer have to rely on your old employer. The only risk you have is the amount of investment risk you choose to take on.

Increased Investment Options

Rolling your pension into an IRA may give you more investment options. Many employers with 401(k) plans have 401(k)s with limited investment options and high fees. Moving to an IRA lets you pick the exact mutual funds, ETFs, stocks, bonds, real estate, and other alternative investments you want to invest in.

If you have a defined benefit plan, you may be able to earn more by cashing it out and investing it. For example, your employer might allow you to cash it in based on a 5% rate of return. If you invest the money in stocks, you might be able to get up to a 10% return.

More Flexibility

An IRA can give you more flexibility than a pension plan. For example, let's say you want to buy a house.

If you have a defined benefit pension, you get your pension payments as scheduled and usually can't take out extra money for a down payment. If you have an IRA, you can take out as much as you need. If you're still under retirement age, there are special rules that let you avoid penalties when you're taking out money to buy a home.

Disadvantages of Rolling a Pension into an IRA

There are two main disadvantages when it comes to rolling a pension into an IRA.

Investment Risk

All investments can lose value, especially over the short term. The stock market has had several crashes where it lost half its value and then went back up over time. Even bonds can lose value due to inflation or changes in interest rates.

The way to avoid investment risk is by building a well-diversified portfolio. Diversification means investing in different types of investments and many different companies.

Diversification is another reason to consider rolling over your pension. Staying in a pension is like investing all your money in that company's stock. If you don't want your retirement to be at risk if something happens to your former employer, you may want to roll your pension into an IRA so you can diversify your retirement savings.

Having to Manage Investments

When you have an IRA, you're responsible for choosing what you want to invest in. Whether this is a disadvantage depends on whether this is something you're comfortable with. Some people want to use an IRA because they want more control over their investments.

If managing your own investments is a disadvantage to you, you have options. You can use a balanced mutual fund or move your money to an IRA that automatically invests your funds for you. All you have to do is choose how much risk you're comfortable taking.

When Does a Pension-to-IRA Rollover Make Sense?

A pension-to-IRA rollover may make sense to you if all or some of the following apply.

  • You want to reduce your risk by not relying on a single employer's pension plan.
  • You have a defined contribution plan with poor investment options or high fees.
  • You believe you can earn a higher rate of return investing on your own.
  • You want additional flexibility.
  • You still intend to keep the money in your IRA until retirement age.
  • You intend to use the money for a purpose that qualifies for early IRA distributions, such as home buying or education.

Frequently Asked Questions

Here are some frequently asked questions about rolling a pension into an IRA.

What happens to my pension in the event of liquidation?

While your previous employer is participating in the activity known as "de-risking," you're likely to be offered a lump-sum. You will have the option to take the payout and pay taxes or rollover your sum into a new retirement plan.

What to do next to avoid tax on my pension? Can I roll over my pension to an IRA?

Yes! According to IRS publication 575, if faced with a lump-sum distribution, you are able to roll over into a Traditional IRA or 401(k) and face no tax or early withdrawal penalty. For most people, this will be the most attractive option, as the income taxes and early withdrawal fees on a lump-sum distribution will be significant, and not be an option for most people.

How do I roll my pension into an IRA?

There are three ways to roll a pension into an IRA.

  • Trustee-to-trustee (most common): You open an IRA and fill out paperwork authorizing your new IRA company to withdraw your pension into your IRA.
  • Direct rollover: You open an IRA and fill out paperwork telling your pension to transfer your funds to the IRA.
  • 60-day rollover: You receive a check from your pension. You have 60 days to deposit the money into an IRA to avoid taxes. If your pension withholds taxes, you must use other funds to roll the full distribution amount into your IRA.

What types of IRA accounts can I choose from?

There are two types of IRA accounts you can use.

A traditional IRA account lets you roll over the money without paying taxes. When you start withdrawing money in retirement, you pay taxes on the withdrawals.

A Roth IRA rollover will require you to pay taxes. In return for paying taxes now, you won't have to pay taxes when you withdraw the money in retirement. This option is usually ideal if you think you're in a lower tax bracket in the year of the rollover than you will be in retirement.

How much can I roll over into an IRA?

There is no limit on the amount of money you can roll into an IRA. IRA contribution limits don't apply to rollovers. Rollovers don't use your IRA contribution limits.

Your employer may have special rules. For example, they may require you to withdraw your entire pension. If they allow partial withdrawals, they may require you to leave a minimum amount in your pension to keep it open.

How do I choose an IRA provider to maximize investing flexibility?

If you have decided to roll over your pension to an IRA, the next step will be to select an IRA. Pensions with only pre-tax dollars will go to a traditional IRA. When choosing an IRA provider, most people are concerned with investment options and fees. Typical IRA providers have a preset menu of mutual funds which works for some investors. However, a Self-Directed IRA provides options and flexibility desired by others.

When selecting a Self-Directed IRA provider, examine the fee schedule. Fees may be high to open and maintain a Self-Directed IRA. High fees diminish investment returns. It's crucial to select a provider who is transparent with their fees, fairly priced and offers you the highest degree of freedom within the account to invest in what you want.

At Rocket Dollar, it's important for us to present an upfront and clear fee schedule. Our fees are $360 to open an account and then $15 monthly.

What are the benefits of a Self-Directed IRA?

If you are considering a Self-Directed IRA , check out this blog post outlining how and when to use a Self-Directed IRA . A Self-Directed IRA can be a great option for people needing to roll over a pension, or any eligible 401(k) for a few reasons.

First, the big IRA providers have limited investment options, and instead funnel you into a predetermined menu of their own funds, meaning that not only you can't invest in what you want, but they can collect fees on every fund you are able to purchase.

Second, having assets outside of stocks and bonds can increase your ability to withstand a market downturn or recession . A Self-Directed IRA is used to invest in assets such as real estate, startups, peer to peer lending, or anything else allowed by the IRS . You are in control of your portfolio.

Can you have more than one IRA?

You are allowed to have as many IRAs as you want to. Many people open multiple IRAs to get access to more investment options. For example, you might want both a traditional brokerage IRA for stocks and a self-directed IRA for real estate.

When you do a rollover, the IRS lets you do multiple rollovers for direct transfers. If you do a 60-day rollover, you have to make a single deposit into a single IRA. You can then move money between IRAs if you want to.

Check with your pension plan for any rules they may have on doing multiple rollovers.

What if you have multiple pensions?

If you have multiple pensions, you can roll them over into the same or different IRAs. The only limit is that you only get one 60-day rollover per year no matter how many pensions you have. It's not one per pension.

Learn more about Self‑Directed retirement plans with our ultimate guide.

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