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How do I complete a rollover?

  1. Direct rollover – If you’re getting a distribution from a retirement plan, you can ask your plan administrator to make the payment directly to another retirement plan or to an IRA. Contact your plan administrator for instructions. The administrator may issue your distribution in the form of a check made payable to your new account. No taxes will be withheld from your transfer amount.  
  2. Trustee-to-trustee transfer – If you’re getting a distribution from an IRA, you can ask the financial institution holding your IRA to make the payment directly from your IRA to another IRA or to a retirement plan. No taxes will be withheld from your transfer amount.  
  3. 60-day rollover – If a distribution from an IRA or a retirement plan is paid directly to you, you can deposit all or a portion of it in an IRA or a retirement plan within 60 days. Taxes will be withheld from a distribution from a retirement plan (see below), so you’ll have to use other funds to roll over the full amount of the distribution.

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Spouse May Need to Sign

Most company pensions work by paying you an income stream for the rest of your life after retirement. When you die, your surviving spouse generally will receive half the amount you received as an annuity. It’s only your spouse who benefits from this arrangement – annuities typically do not get paid to surviving children.

If you are married, then your spouse must give up his or her right to an annuity interest before you can move the money to an IRA. Most plan administrators will require the notarized signature of your spouse before they will complete the rollover. The plan administrator can tell you what forms need to be signed.

One advantage of a rollover is that you can choose who gets your IRA when you die. For example, you could leave everything to your spouse or name your spouse and child as 50/50 beneficiaries, so they get half the funds each. There’s more flexibility.

Cons of Rolling Over a Pension into an IRA

Con: No loan option

When you roll over to an IRA, you give up your ability to take loans on your retirement savings. Pension plans may allow participants to borrow or take an advance on their accumulated savings, sometimes up to 50% of their pension contribution. However, this benefit is not available in an IRA. Instead, you may be forced to take an early withdrawal that is subject to income taxes and penalties.

Con: You plan to retire at 55

Pension plans allow participants to take a penalty-free distribution when they retire or leave the company at 55 years. However, by rolling over to an IRA, you will have to wait until you are 59 ½ to take a penalty-free distribution. If you withdraw funds before 59 ½, you will have to pay a 10% penalty for early withdrawals, which could take a huge chunk of your retirement money.

Con: Lost creditor protection

The retirement savings accumulated in a retirement plan are creditor-protected, and creditors cannot seize your funds when enforcing a collection or in bankruptcy situations. However, funds rolled over to an IRA do not receive the same level of protection as funds in employer-sponsored retirement plans. Each state has different rules on the amount of IRA funds that are protected from creditors.

Disadvantages of Rolling Your Pension Into a Roth IRA

You’ll Owe Taxes Up Front

If you decide to roll over your pension lump sum into a Roth IRA, you’ll owe income tax on the money just as you would with any other Roth IRA contribution. After that, the money in your Roth will grow tax deferred and be eligible for totally tax-free withdrawals if you meet the rules.

Responsibility for Investing

Rather than leaving the burden on your employer, you’ll be responsible for deciding how to invest the money in your IRA. You may see this as an advantage or a disadvantage depending on how comfortable you are with managing investments.

No Guarantees

When your money is in a pension plan, your employer promises that you’ll receive benefits of a certain dollar amount starting at some point in the future. While some employers fail to live up to their promises for one reason or another, your benefits may be insured by the federal Pension Benefit Guaranty Corp. Roth IRAs carry no such guarantees.

Pros Tax-free withdrawals More control over investments Easier access to your money No required minimum distributions (RMDs) Cons You’ll owe taxes up front Responsibility for investing No guarantees

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.

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.

How to Rollover a Pension Plan: The Direct Method

Rolling your pension into an IRA is an extremely simple procedure if you follow the direct method. The first step is to set up an IRA if you don’t already have one. Then, you’ll need to speak to your employer and request the paperwork needed to initiate a distribution from the pension plan. The main point is to request a “direct” rollover to your IRA custodian. This will set in motion a direct monetary transfer from one account to the other. The pension plan administrator and the IRA custodian will organize the transfer behind the scenes – your only job is to fill out the paperwork.

Normally, requesting a distribution from a pension would trigger a tax liability in the year in which you take the distribution. It would also trigger a 10 percent early payment penalty if you are under 55. By rolling the account balance over, you eliminate that tax liability. The rollover is tax neutral with no taxes or penalties to pay. Your rollover will be taxed later when you begin taking distributions, presumably when you retire.

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.

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.

Should I roll my pension into a Roth IRA?

A Roth IRA has advantages and disadvantages compared with simply leaving your money in an employer’s pension plan. While the Roth will allow you to take tax-free distributions later (unlike the pension), you will have to pay taxes on the Roth IRA contribution up front.

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.

Is my retirement plan required to accept rollover contributions?

Your retirement plan is not required to accept rollover contributions. Check with your new plan administrator to find out if they are allowed and, if so, what type of contributions are accepted.

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