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Should You Rollover Your Pension to IRA?

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When you leave your job, you have a few options when it comes to your pension. You can take the pension payout over your lifetime, cash it out as a lump sum payout, or you can roll over your pension into an IRA.

But what’s the best option for you? The short answer is: It depends.

I know that’s not the answer you want to hear, but it truly does depend on your unique financial situation.

For most people, rolling over their pension into an IRA is the best choice. In this article we’ll look at the reasons why rolling over your pension is often the best decision, as well as some situations where it might not be the best idea.

What is a Pension?

A pension is a retirement savings plan that is typically offered by an employer. pensions are tax-deferred, which means you don’t have to pay taxes on the money you contribute to your pension until you withdraw it in retirement.

There are two types of pension plans: defined benefit and defined contribution.

What is a Defined Benefit Plan?

A defined benefit plan is a pension that pays you a set amount of money in retirement, based on your years of service and salary. These types of pension plans continue to dwindle as companies increasingly switch to defined contribution pension plans, such as 401k plans.

According to US News and World Report, only 20 percent of private-sector workers have a defined benefit pension plan.

Public sector employees are more likely to have a defined benefit pension plan. According to the National Institute on Retirement Security, over 80 percent of state and local government workers have a pension.

The most common types of employment that still offer pensions are education (think teachers).

Types of pensions payouts can include:

  • Life only: You receive pension payments for as long as you live.
  • 10-year certain: You are guaranteed to receive pension payments for at least 10 years, even if you die before then.
  • Joint and survivor: pension payments continue to be paid to a surviving spouse after your death.

Some pensions may offer additional payout options, but these are the most common. Typically, if the employee chooses the “joint and survivor” option the monthly payment is reduced because the payments have to last for two people.

For example, I have one client who elected this option and was receiving $2,625 per month for himself and his wife. Had he elected the “life only” option his payment would have been $3,475 per month.

What is a Defined Contribution Plan?

A defined-contribution plan is a pension that allows you to contribute a set amount of money into the pension, typically through payroll deductions. The pension is then invested, and the money grows over time -the power of compounding interest!

They are more commonly known as a 401k, 403b, or 457 plan. The amount of money you have in retirement depends on how much you and your employer contributed, as well as how much the investments earn.

Also related: Choosing the Best Retirement Plan For You

401k plans can also offer a match, which is free money from your employer.

For example, if your employer offers a 50 percent match on 401k contributions up to 6 percent of your salary, that means they will contribute 50 cents for every dollar you contribute, up to 6 percent of your salary. So if you make $50,000 per year and contribute 6 percent ($3,000), your employer would contribute an additional $1,500.

What is a Pension Rollover?

A pension rollover is when you take the money from your pension and roll it over into an IRA. In essence, you are foregoing the pension payments in retirement and instead opting to manage the money yourself in an IRA.

According to IRS regulations, you have 60 days from the day you receive the pension payout to roll it over into an IRA. If you don’t do a pension rollover within that 60-day window, the money will be considered a withdrawal and you’ll have to pay taxes on it, as well as a 10 percent early withdrawal penalty if you’re under age 59 1/2.

These rules closely resemble a 401k rollover.

The 10% early withdrawal penalty is a big deal but easily avoidable by working with a qualified professional.

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Why Should You Roll Your Pension into an IRA?

There are several reasons why rolling over your pension into an IRA is a good idea. Here are five to consider:

1. More Investment Control

First, rolling over your pension into an IRA gives you more control over your retirement savings. With an IRA, you can choose how your money is invested. For example, you can choose to invest in stocks, bonds, and mutual funds.

Many of my clients who had pension plans opted to roll over their pension into an IRA so they could invest in a wider variety of investments, including real estate and alternative investments.

2. Save Money on Paying Taxes

Second, rolling over your pension into an IRA can also save you money on taxes.

With a pension, you will have to pay taxes on the money when you withdraw it in retirement. However, with an IRA, you can defer paying taxes on the money until you withdraw it in retirement.

3. More Flexibility

Third, rolling over your pension into an IRA can give you more flexibility in retirement.

With an IRA, you can take out money whenever you want without penalty. However, with a pension, you may have to wait until you reach a certain age before you can withdraw the money.

4. More Income (Possibly)

Fourth, rolling over your pension into an IRA can also provide you with more income in retirement.

With an IRA, you can take out the money as needed in retirement. However, with a pension, you may have to wait until you reach a certain age to start receiving benefits.

5. Better Death Benefits

Lastly, rolling over your pension into an IRA can also provide better death benefits for your beneficiaries.

With an IRA, your beneficiaries will receive the money tax-free. However, with a pension, your beneficiaries may have to pay taxes on the money they receive.

So, what’s the best choice for you? It depends on your situation. Before we answer that question, let’s first look at some of the disadvantages of rolling over your pension into an IRA.

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Cons of Rolling a Pension into an IRA

There are a few potential downsides to rolling over your pension into an IRA.

1. Potential Tax Penalties

First, if you roll over your pension into an IRA and then take a distribution before you reach age 59 1/2, you may be subject to a 10% early withdrawal penalty.

2. Loss of Death Benefits

Another potential downside of rolling over your pension into an IRA is that you may lose the death benefits that are associated with the pension.

Pensions typically have death benefits, which means that your beneficiaries will receive a lump sum of money if you die before you retire. However, if you roll over your pension into an IRA, your beneficiaries will not receive the death benefits.

3 . Loss of Other Benefits

If you are a part of a union then cashing out or rolling over your pension may disqualify you from perks you were previously entitled to. This could be discounts on insurance, local businesses, and other amenities.

Of all these miscellaneous benefits I’ve reviewed I’ve never seen anything that was crucial enough to leave the pension with the company.

Other Factors to Consider

1. Financial Strength of Your Company

Deciding on whether to choose the lifetime income option vs. the lump sum might be as easy as evaluating the overall financial strength of the company you work for.

As I have mentioned before in a previous post “Company is Going Bankrupt, What About My Pension“, your pension is insured by the PBGC (Pension Benefit Guaranty Corporation), but it’s only up to $67,009.20 and that’s only if you retire at 65 and select the Joint and 50% Survivor annuity.

Over and above that, then you are out of luck. Any pension amount that is over the $67,009.20 limit will make the decision to take the lump sum more attractive.

2. How is Your Health?

Does your family have a history of illness? If so, then taking the lump sum and rolling it to an IRA might be the most viable option. What’s the point of having an income for the rest of your retirement if you are only in retirement for a few short years?

I have a client whose never-married friend had worked for a company for almost 30 years. When that person retired, they optioned to take the annuity option and receive monthly payments. Just after three months of receiving their checks they unexpectedly passed away.

Guess what happened to the remainder of the pension benefit? It all went back to the company since they didn’t have a spouse to pass it on to.

If they had rolled the pension into an IRA, they could have elected another family member to receive it or at least donated it to a charity or their church.

3. Beneficiary Minded

Most pensions work in that you (the employee) will receive an income stream for the remainder of your life. When you pass, your surviving spouse will receive half of the amount you received. (Some pensions do allow for your spouse to receive the full benefit, but typically you would have had to take a lesser amount in the beginning).

If your spouse predeceases you, then there’s no more to be paid. Same when your spouse passes- the payment stops with him or her. If you have surviving children, they will not receive a dime from the pension.

By opting to roll over your pension into an IRA, you will at least have the option to pass the remainder (if any) to your heirs. Also, if done effectively, they might be able to stretch the IRA over their lifetime.

4. Lump Sum Pension Payment Vs. Monthly Benefit

The last determinant is just like the old song lyric goes, “It’s All About the Benjamin’s“. You need to closely analyze how much the lump sum pension benefit option is versus the monthly benefit.

Let me highlight two situations where the choice was fairly obvious.

Pension Rollover Case Study #1

I had one client who was offered an early buyout on his pension.  He was almost 55 yet so he could start taking the payments immediately. The monthly benefit that they were offering was approximately $3000 per month.

He had elected to choose a lower amount (the $3000) so that his spouse would receive the same amount for her lifetime. That wasn’t a bad option, but just to be sure, let’s look at the lump sum amount.

The pension was an older one that was more beneficial to tenured employees so the lump sum amount was only around $250,000.  I say “only” because assuming no growth on the dollar amount, then the client would have completely exhausted his pension in just under 7 years right before he turned 62.

In this case, it was a no-brainer to select the guaranteed monthly benefit.

Pension Rollover Case Study #2

Another client had just turned 62 and her company was offering her a lump sum amount of $600,000.  Not to bad, but let’s look at the monthly benefit.  The monthly benefit amounted to $4,000 per month ($48,000) per year. Thus far it’s not such a clear-cut decision.

What made it crystal clear was that the client has had a 401k with the same employer for just over $200,000 and had a sufficient emergency fund plus minimal debt. On top of that, they had 3 kids in which they desired to pass an inheritance to. Believing that they would never outlive their retirement nest egg, it may complete sense to roll over the pension into an IRA.

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What if You’re Still Working?

One last point that I should mention is that you don’t have to wait until you officially retire to roll over your pension.  Once you reach the IRS’s magic age of 59 1/2, you can elect to do what’s called an “In Service Distribution“.

Even if you plan to continue to work, you can elect to roll over your pension amount into an IRA. Your pension will then to continue to accrue with your employer and you have complete control of your money outside of your employer’s hands. This also works with 401k plans as well.

I’ve had several clients execute this strategy flawlessly.

Pension Rollovers – The Bottom Line

Deciding on the fate of your pension is a very important decision. Review your options more than once and seek counsel from different parties. I suggest meeting with a Certified Financial Planner and a CPA to help decide which option is best for you.

Pension Rollover FAQs

Can You Rollover Your Pension into a Roth IRA?

Yes, you can roll over your pension plan into a Roth IRA. Choosing this option could be a hefty tax burden depending on the size of your pension, so be sure to speak with a tax advisor before making this choice.

How Do You Know if You’re Eligible for a Rollover?

The best way to find out if your pension plan is eligible for a rollover is to contact your pension plan administrator. The most common triggering event is leaving your job. But other factors such as disability, early retirement, or pension plan termination can also make you eligible.

What’s the Difference Between a Rollover and a Transfer?

A pension rollover is when you take the money from your pension and roll it over into an IRA. A pension transfer is when you transfer the money from your pension into another pension plan. This is a unique situation as most pensions won’t accept outside money from other pension funds.

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