Many employers offer 401(k)s or similar retirement plans to employees, but there are still some companies that sponsor traditional pension plans. Under a pension plan, your employer kicks in a certain amount of money to the plan and you're guaranteed a specific benefit once you retire. These plans are typically set up to pay your benefits monthly but you may have the option of taking a lump sum. Lump sum pension distributions can then be rolled into an IRA. Some companies are closing out their pension plans, giving workers the opportunity for a pension rollover to an IRA or another retirement account.
How to Roll Pension into IRA
Before you roll over your pension benefits, you'll need to decide which type of IRA you want to set up. You have two choices when you roll a pension into an IRA. You can transfer your money to a traditional IRA or a Roth IRA. If you plan to keep kicking in cash to your IRA after the rollover, a traditional IRA gives you a tax deduction for contributions. If you'd prefer to roll your money over into a Roth IRA, the IRS treats it like a conversion, which means you'll have to pay income tax on the amount you're transferring. The upside is that once the rollover is complete, your money will continue to grow tax-free.
Rules and Exceptions
The easiest way to transfer your pension to an IRA is to initiate a direct rollover, also called a trustee-to-trustee transfer. With this type of rollover, the plan administrator is responsible for moving the balance of your pension account to your IRA. You provide your IRA account information and the plan administrator can transfer the money electronically or cut a check to the institution that holds your account. The biggest advantage of using the direct rollover option is that it allows you to avoid paying a 20 percent federal withholding tax on the money you're transferring.
Make sure you can do the rollover, however. You need to be either have left your job with the company or government agency, or your employer needs to offer to close out your pension plan. If you have left employment, your former employer will provide you with the paperwork you need to initiate the rollover.
If your plan administrator doesn't offer the direct rollover option, you can also transfer your pension benefits to an IRA manually. This means that instead of sending the money to your brokerage, the plan administrator sends a check directly to you. The administrator is required to automatically withhold 20 percent for taxes. Once you get the check, you have 60 days to complete the rollover into an IRA. If you don't roll the money over in the 60-day time frame, then the total amount is treated like income, which means you'll owe income tax on the distribution.
If you opt for an indirect rollover and you're subject to the 20 percent withholding, the IRS considers it a taxable distribution. You can avoid paying additional taxes on the amount that was withheld by making up the difference when you complete the rollover. The amount that was withheld would then be applied towards your future tax liability. You should also keep in mind that if you're under age 59 1/2, an additional 10 percent early withdrawal penalty will apply if you don't make up the withholding difference when you roll the money over.
The 2018 Tax Law
You can only roll over one pension plan per 365-day period, a rule that has been in effect for several years. There are few changes in the rules over the past few years for rolling over pensions. If you are rolling over a pension into a new employer's retirement plan, say a 401k, check with your human resources director to make sure you can do a pension lump sum rollover to a 401k; otherwise you'll have to find a qualified plan to avoid the tax penalty.
The 2017 Tax Law
Make sure you stick to the 60-day rollover period in order to avoid the penalties. Also, make sure you are choosing a qualified retirement plan. Those are the two biggest takeaways when rolling over your pension into an IRA.
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- The Tax Consequences of Merging an SEP IRA & a Rollover IRA
- How to Convert a Keogh to an IRA
- What Are Your Options Once You've Cashed Out Your 401K?