If you are wondering what to do with your pension plan, check out the pros and cons of rolling over a pension into an IRA. 3 min read.
If you are leaving your employer, you need to make the right decision for your pension plan. You can either cash out the money or move it to an IRA or the retirement plan of a new employer. Each of these choices may have an effect on your taxes, and you may have to pay income taxes on the distribution as well as a 2010%%20penalty%20tax if you are below%2059%20%C3%82%C2%BD.
To start a rollover from a pension plan to an IRA, you need to have a qualifying event. Usually, you canât rollover your pension plan if you are still working with the current employer. You must have separated from your employer or the employer is ending its pension plan. If the company goes out of business, files for bankruptcy, or merges with another, the pension plan may end.
Making the right choice about your retirement funds can mean the difference between financial security and sleepless nights If you’re staring down this fork in the road – should you keep your pension or roll it over to an IRA? – you’re not alone This decision affects millions of Americans approaching retirement or switching jobs,
There’s no one answer that works for everyone, and I’ve helped a lot of clients make this tough choice. What’s best for you depends on your finances, how willing you are to take risks, and your retirement goals. We’ll go over everything you need to know to make the very best choice for YOU.
Understanding What’s at Stake
Before diving into the pros and cons, let’s get clear on what we’re talking about
Pension (Defined Benefit Plan): This is a retirement plan paid for by your employer that guarantees a certain amount of money when you retire. The amount of the benefit depends on how long you worked for the company and how much you were paid.
IRA Rollover: This involves transferring your pension funds into an Individual Retirement Account that you control. You decide how it’s invested and when to withdraw (within certain rules).
Key Factors to Consider
1. Guaranteed Income vs. Investment Control
Pension Advantage: Predictable, lifelong income stream regardless of market conditions.
IRA Advantage: Complete control over your investments with potential for higher returns.
This is probably the biggest tradeoff you’re facing. With a pension, you get that sweet guaranteed paycheck for life. It’s simple, predictable, and you don’t have to worry about the stock market tanking right before you need the money.
But with an IRA, you’re in the driver’s seat. You might be able to make your money grow faster, change how you invest it if you need to, and leave your heirs more money. But that control comes with responsibility and risk.
2. Financial Strength of Your Employer
Is your former employer rock-solid financially? Or are they struggling to stay afloat?
Your pension is only safe as the company that backs it. The Pension Benefit Guaranty Corporation (PBGC) protects defined benefit plans in the private sector, but only up to $67,009 Good Financial Cents says that people who retire at age 65 get $20 a year.
If your pension exceeds this amount and you have doubts about your employer’s long-term financial health, rolling over to an IRA might be the safer option.
3. Life Expectancy and Health Considerations
This factor is tough to think about, but crucial. If your family history suggests a longer-than-average lifespan, a pension’s guaranteed lifetime income becomes more valuable.
Conversely, if you have health concerns or a family history of shorter lifespans, an IRA might be preferable since any remaining funds can be passed to your heirs.
I had a client whose never-married friend worked for nearly 30 years at one company. They chose the monthly pension option but passed away just three months after retiring. All that pension money went back to the company since there was no spouse to continue receiving benefits. If they had rolled it into an IRA, they could have designated another beneficiary or donated it to charity.
4. Beneficiary Considerations
Pension: Most pensions provide income only for your lifetime, with possibly reduced payments to a surviving spouse. When both of you pass away, the payments stop completely.
IRA: You can name any beneficiaries you choose, and they’ll inherit whatever remains in your account when you die. This can be a powerful estate planning tool.
5. Tax Implications
Both options have tax considerations:
Pension: Payments are typically taxed as ordinary income when received.
Traditional IRA Rollover: No immediate taxes, but withdrawals in retirement are taxed as ordinary income.
Roth IRA Conversion: If you convert to a Roth IRA, you’ll pay taxes upfront on the converted amount, but qualified withdrawals in retirement are completely tax-free.
According to Investopedia, “If you 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.”
6. Lump Sum vs. Monthly Payment Analysis
Let’s look at this with some real numbers:
Case Study 1: A client was offered an early pension buyout of approximately $250,000 or monthly payments of $3,000 for life. At that rate, the lump sum would be exhausted in less than 7 years. Keeping the pension was clearly the better choice.
Case Study 2: Another client was offered a $600,000 lump sum or $4,000 monthly ($48,000 annually). With additional retirement savings of $200,000 elsewhere, minimal debt, and three children they wanted to leave an inheritance to, rolling over to an IRA made more sense.
7. Access to Funds and Liquidity
Pension: Your principal is inaccessible; you only receive the predetermined payments.
IRA: While there are rules about withdrawals (including penalties for early withdrawals before age 59½ and Required Minimum Distributions starting at age 73 for traditional IRAs), you generally have more flexibility to access funds if needed.
Practical Implementation: How to Roll Over Your Pension
If you decide that rolling over your pension to an IRA is the right move, here’s how to do it:
Direct Rollover (Recommended)
This is the simplest and safest approach:
- Open an IRA account at your chosen financial institution
- Contact your pension plan administrator and request a direct rollover form
- Specify the new IRA account information on the form
- Submit the completed form to your pension administrator
- Verify that the transfer is complete after a few weeks
With a direct rollover (trustee-to-trustee transfer), the money goes straight from your pension plan to your IRA without passing through your hands. This avoids mandatory tax withholding and potential penalties.
Indirect Rollover (60-Day Rollover)
This is less desirable but sometimes necessary:
- Receive a distribution check from your pension
- Deposit the full amount into an IRA within 60 days
- Note that 20% will typically be withheld for federal taxes, which you’ll need to make up from other sources to avoid taxes and penalties
If you don’t complete the rollover within the 60-day window, the unrolled portion becomes taxable income and may incur an early withdrawal penalty if you’re under age 59½.
Real-World Considerations
Here are some additional real-world factors that might influence your decision:
The “In-Service Distribution” Option
You don’t always have to wait until retirement to roll over your pension. Once you reach age 59½, you may be eligible for what’s called an “In-Service Distribution,” which allows you to roll over your pension while still working for your employer.
This can be beneficial if you want to gain control of your investments earlier while continuing to accrue additional pension benefits through continued employment.
Current Market Conditions
The prevailing interest rate environment can significantly affect the value of a pension lump sum. When interest rates are low, lump sum values tend to be higher. This is because the pension administrator uses a discount rate to calculate the present value of future pension payments.
Fee Comparison
IRAs may involve account maintenance fees ($25-$75 annually), transaction fees, and investment management fees. Pension plans typically have administrative costs covered by the employer.
When to Keep Your Pension
You might be better off keeping your pension if:
- You value guaranteed income above all else
- You have low risk tolerance and anxiety about market fluctuations
- Your employer is financially stable
- You expect to live a long time
- You don’t have significant other retirement savings
- You’re not comfortable making investment decisions
- The monthly pension amount is significantly better than what you could generate yourself
When to Roll Over to an IRA
An IRA rollover might be the better choice if:
- You want control over your investments
- You’re concerned about your former employer’s financial stability
- You have significant other retirement assets
- You’re comfortable managing investments or working with an advisor
- You want flexibility in accessing your funds
- You have strong beneficiary/inheritance goals
- The lump sum offer is unusually generous
A Balanced Approach: The Partial Solution
Sometimes, the best answer isn’t all or nothing. If your pension plan allows it, you might consider taking part of your pension as a lump sum to roll over, while keeping part as a monthly payment.
This hybrid approach can provide some guaranteed income while also giving you flexibility and control over a portion of your retirement assets.
The Bottom Line
Deciding whether to keep your pension or roll it over to an IRA is one of the most significant financial decisions you’ll ever make. It requires careful analysis of your specific situation and goals.
I strongly recommend consulting with both a Certified Financial Planner and a CPA before making your decision. They can help you run the numbers specific to your situation and consider all the relevant factors.
Remember, what worked for your coworker or neighbor might not be right for you. Your retirement, your rules!
Have you faced this decision? What factors swayed your choice? I’d love to hear about your experiences in the comments.
FAQ: Pension vs. IRA Rollover
Q: Can I roll over my pension to a Roth IRA?
A: Yes, but you’ll need to pay income tax on the amount converted. After that, qualified withdrawals will be tax-free.
Q: Are there limits on how much I can roll over from my pension to an IRA?
A: Unlike annual contributions, there are no limits on IRA rollovers.
Q: What happens if my company goes bankrupt? Is my pension safe?
A: The PBGC insures many private sector pensions, but only up to certain limits (currently around $67,000 annually for those retiring at 65).
Q: Do I need my spouse’s consent to roll over my pension to an IRA?
A: If your pension lump sum would be worth $5,000 or more and you’re married, you’ll generally need your spouse’s written consent to take it as a lump sum.
Q: Can I still work for my employer and roll over my pension?
A: Once you reach age 59½, you may be eligible for an “In-Service Distribution,” allowing you to roll over your pension while still employed.
Whatever path you choose, make sure it aligns with your broader retirement strategy and personal goals. Your retirement should be a time of security and enjoyment, not financial stress!
Pros and Cons of Rolling Over a Pension Plan into an IRA
If you roll over your pension plan into an IRA, you can choose from a wider range of investments, avoid paying taxes, have more control over your retirement savings, and be more flexible with when you take money out. The cons of rolling over into an IRA include lost creditor protection, no loan options, and penalties on early retirement.
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If you are wondering what to do with your pension plan, check out the pros and cons of rolling over a pension into an IRA. 3 min read.
If you are leaving your employer, you need to make the right decision for your pension plan. You can decide to cash out, or rollover the funds to an IRA or a new employerâs retirement plan. Each of these options may have a tax implication, and you may be required to pay income taxes on the distribution, and a 10% penalty tax if you are below 59 ½.
When rolling over a pension plan to an IRA, you must have a qualifying event to initiate a rollover. Usually, you canât rollover your pension plan if you are still working with the current employer. You must have separated from your employer or the employer is ending its pension plan. A pension plan may be terminated when the company has been closed down, declares bankruptcy, or is merged with another company.