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, rather than having the money paid out over time. You could roll your money over into an IRA account. Some things to consider before rolling your pension over into an IRA:
What is a 401(k) rollover?
A 401(k) rollover is when you take the money in your 401(k) plan and transfer it to a new 401(k) plan or IRA. If you receive a distribution from an IRA or retirement plan, you have 60 days to roll it over to another plan or IRA.
How to start your 401(k) rollover
1. Decide what kind of account you want
What you want to do with your money will help you decide what kind of account to roll it over into. If you want more control over where your money goes, you might want to invest it yourself.
There are two primary options to consider when rolling over a 401(k): transferring it to your current 401(k) or rolling it into an IRA. As you’re trying to decide, ask yourself the following questions:
- Do you want to invest the money yourself or would you rather have someone do it for you? If you want to do it yourself, an IRA may be a good option. But even if you want someone to do it for you, you may want to check out an IRA at a robo-advisor , which can design a portfolio for your needs. But “do-it-for-me” investors may also prefer to make a rollover into your current employer’s 401(k) plan.
- Does your old 401(k) have low-cost investment options with potentially attractive returns, and does your current 401(k) offer similar or better options? If you’re thinking about a rollover to your current 401(k) plan, you’ll want to ensure it’s a better fit than your old plan. If it’s not, then a rollover into an IRA could make a lot of sense, since you’ll be able to invest in anything that trades in the market. Otherwise, maybe it makes sense to keep your old 401(k).
- Does your current 401(k) plan offer access to financial planners to help you invest? If so, it could make sense to roll your old 401(k) into your new 401(k). If you move money to an IRA, you’ll have to manage it completely and pick investments or hire someone to do so.
You will need to decide what kind of account is best for you before you move your money. If you are unsure about investing your money, you may want to consider rolling it over into your 401(k) plan. If you are confident in your abilities to invest the money yourself, you may prefer to open an IRA.
2. Decide where you want the money to go
If you are rolling over your old 401(k) account to your current one, you will know exactly where your money is going. You will need to set up an IRA at a bank or brokerage if you want to roll your 401k over to an IRA.
Bankrate has looked at the best places to move your 401(k), including investment opportunities for those who want to do it themselves, and robo-advisor options for those who want a professional to design a portfolio for them.
Our brokerage reviews can help you compare key areas at each provider. In this text, you will find information on various topics related to banking, including minimum balance requirements, investment offerings, customer service options, and ratings in multiple categories.
If you have an IRA, you may be able to transfer your 401(k) into it, or you may be able to create a new IRA for your 401(k) funds.
3. Open your account and find out how to conduct a rollover
You will need to open an IRA account with a brokerage or robo-advisor that meets your needs. You can roll over your 401(k) money into the account once it’s open.
To rollover your account, you’ll need to contact the institution for your new account to see what exactly is needed as each brokerage and robo-advisor has its own process. You’ll want to follow their procedures exactly. If you’re looking to move your 401(k) from your old employer to your new employer, reach out to your new plan administrator for more information.
For example, the 401(k) company might be sending a check and your IRA institution could request that the check is written in a certain way. They might also require that the check has your IRA account number on it.
Again, follow your institution’s instructions carefully to avoid complications.
4. Begin the rollover process
You will need to fill out paperwork to be able to do a rollover of your investment, which may require some conversation with your providers. You have a few different ways to move the money from your old provider to your new one, but your best option is a direct rollover.
The funds are transferred directly from your old 401(k) account to your new account without you receiving the funds first. When choosing to rollover your 401k, be sure to specify that you want a direct rollover so the check is not made out to you. If you make withdrawals from your account before you turn 59 1/2, the IRS will charge you a 10 percent penalty on top of the mandatory 20 percent withholding for taxes.
5. Act quickly
If you rollover your retirement plan distribution, you have 60 days from the date you receive it to deposit it into a qualified account. Otherwise, it will be a taxable event.
The process for each institution may vary for transferring money. The administrator of your 401(k) account may send you a paper check or roll the money over to your Individual Retirement Account (IRA) electronically via wire transfer.
If you are sent a check in the mail, you will need to send it to your new account. Act quickly.
Rules When Rolling a Pension Into an IRA
When you roll your pension over into an IRA, you transfer the money in your pension plan into an IRA at a broker of your choice. If you adhere to the IRS regulations, you usually won’t be subject to taxes or penalties for taking this action.
There are two types of pensions: those where benefits are predetermined (defined benefit) and those where the pension is funded by employee contributions (defined contribution). The rollover process for a pension plan varies depending on the type of plan.
Defined Contribution Plans
The amount of money you put into a defined contribution plan each month is fixed. This is an example of how you could tell your employer to contribute a portion of your paycheck to your savings plan.
The most common type of defined contribution plan is 401(k)s. A Simplified Employee Pension, or SEP IRA, is also used by some small employers.
When you roll over a defined contribution pension, you are able to take all of the money you contributed plus your investment gains and roll it over into another pension. You can roll over $50,000 from your current account into your IRA if it is worth $30,000.
Your employer’s contributions to your 401(k) become fully yours after you’ve held the job for a certain amount of time, known as the vesting period. Vesting rules vary by employer. If your employer tells you that you will 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 more than three years.
Defined Benefit Plans
A defined benefit plan is a type of retirement plan in which 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 if you have been with the company for 25 years and are age 55. The most common type of retirement plan for government jobs is a pension plan.
Although you can rollover a defined benefit plan, it is more complicated than a defined contribution plan. Your employer has to allow early pension plan withdrawals. The government also has a rule in place dictating how much money one receives if they elect to cash out their pension plan prematurely.
If you are able to cash in your pension early, you will generally receive a smaller sum of money than you would have in retirement. If your retirement pension would be worth $500,000 in retirement, you might only be able to access and rollover $200,000.
Benefits of Rolling a Pension Into an IRA
Some benefits of rolling a pension into an IRA are that you may have more investment options, be able to take advantage of catch-up contributions if you’re over 50, and pay less in taxes overall.
Save on Income Taxes
There are two main tax benefits to rolling a pension into an IRA. If you want to do a rollover from a qualified pension into a Traditional IRA, you can do it tax-free as long as you properly deposit the funds.
You have more control over when you pay taxes on distributions. Typically, you will have to pay taxes on your pension payments once you reach retirement age, which is around 55. When 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 way to lower your taxes is to convert your funds into a Roth IRA. You can choose to pay taxes on a Roth conversion whenever you want, without penalties. One common strategy is to leave your money in a traditional IRA for the first year, then convert it to a Roth IRA in a year when you’re in a low tax bracket.
Reduce the Risk of Losing Your Pension
Retirees have often lost their pensions or a part of their pensions when their former employer has gone into bankruptcy or had other financial problems. If you roll your pension into an IRA, you no longer have to rely on your old employer for retirement benefits. The only risk you have is the amount of investment risk you choose to take on. You can choose how much risk you want to take on, and this will determine the potential reward you could receive.
Increased Investment Options
If you roll your pension into an IRA, you may have more investment options. Many 401(k) plans have limited investment options and high fees. You can choose to invest in a variety of different options when you switch to an IRA, including mutual funds, ETFs, stocks, bonds, real estate, and other alternative investments.
If you have a defined benefit plan, it may be beneficial to cash it out and invest the money. Your employer might, for example, allow you to cash in your 401(k) based on a 5% rate of return. If you put your money into stocks, you may see a return of around 10%.
More Flexibility
An IRA account can provide more freedom in how you use your money than a traditional retirement plan. For example, if you want to buy a house, you would need to save up money for a down payment, get a mortgage, and so on.
If you have a defined benefit pension, your pension payments are scheduled and you usually cannot take out extra money for a down payment. You can take out as much as you need from your IRA. If you are younger than retirement age, you can avoid penalties when you withdraw money from your retirement account to buy a home.
Disadvantages of Rolling a Pension into an IRA
The two main disadvantages of rolling a pension into an IRA are losing the death benefit and having to take required minimum distributions.
Investment Risk
This is because 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 took years to rebound. Despite being considered a relatively secure investment, bonds can still be affected by things like inflation or changes in interest rates, which can cause their value to decrease.
One way to reduce investment risk is by diversifying your portfolio. If you diversify your portfolio, you are investing in different types of investments and many different companies. Diversification can help you reduce risk because it means that your portfolio is not dependent on any one investment or company.
Rolling over your pension is another way to diversify your investment portfolio. When you stay in a pension, you are investing all of your money in that company. If you are worried that your retirement savings will be affected if your former employer goes under, you can roll your pension into an IRA. This will allow you to diversify your retirement savings and protect yourself.
Having to Manage Investments
You have to choose what to invest in when you have an IRA. The disadvantage of this is that it may not be something you’re comfortable with. Some people want to use an IRA because they have more control over their investments than with other investment options.
If you’re not good at managing your own investments, you have options. A balanced mutual fund is an option for where to invest your money. Another option is an IRA that automatically invests your funds for you. To figure out how much risk you’re comfortable taking, all you have to do is choose.
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