Know The Rules Before You Roll Over Your Pension

The days of traditional pensions are coming to an end as companies continue turning to 401(k)s for employee retirement plans. Some members of today’s workforce, mostly Generation X and older, were lucky to be enrolled in blue-chip pension plans before they were no longer offered. However, new pension access has plummeted to 4% of the workforce.

One of my friends was enrolled in a Fortune 500 company’s pension plan before it was no longer offered several years back. Eventually, he received a letter letting him know he was one of the thousands of employees to whom the company was offering a pension buyout or freeze. This is becoming a recurring trend, according to MarketWatch, as GE, Avery Dennison, UPS, IBM and DuPont are among companies that have stopped or frozen their pensions in recent years. Therefore, more workers need to be aware of what to do should their pension be frozen.

There can be any number of reasons for a company to freeze its pensions, but a lot of the time it comes down to the bottom line that pensions are expensive for companies, especially ones with thousands of employees. Since the 401(k) plan popped into existence, companies can put the responsibility of saving for retirement on employees rather than themselves.

Pension freezes can play out a few ways, according to the Pension Rights Center:

• The company can completely bar all employees from earning additional benefits.

• The company can stop enrolling new employees in its pension plan, but continue it for current employees.

• The company can bar employees from receiving pension credit for future years of work under the plan, but allow their benefits to be based on how much they earn when they leave the plan, rather than the date of the freeze.

The last two options may be acceptable enough that an employee might not even consider a rollover at all. But the first option is similar to the situation my friend was in, and that makes a rollover a good option.

My friend was offered two options: receive a lump-sum payout or start his monthly pension payments early. His nest egg was getting booted from the nest. My friend wasn’t even planning to retire for at least another 15 years. While he chose to take the lump sum, he said the decision on where to place the taxable funds was intimidating. This is an important decision to ensure there are more than enough funds available when a person does decide to retire. Generally, once a lump-sum distribution is official, you will want to complete a rollover yourself within 60 days.

IRS Rules For A Pension Rollover And Tax Implications

You will need to follow IRS Publication 575 should you decide to roll over your pension balance. These rules also apply to 401(k) plans and similar retirement accounts, such as a 403(b). The rules for rolling over pension plan balances are important to follow so you do not incur hefty, unnecessary taxes. 

Regarding a lump-sum distribution, you must roll it over from a pension into a tax-advantaged account, according to the IRS. Below are general tax guidelines to consider when receiving a lump-sum payout and the rules for which type of account chosen will then apply.

If your pension has stock, you will need to sell the stock. According to the rules, you’re specifically not allowed to retain the stock and roll over an equivalent amount of cash. You must sell the stock and roll over cash. An individual retirement account provider may be able to pay to move that asset over for a fee.

• Rollover to a Roth IRA: Your funds are considered taxable income the year the rollover occurs, but future income and gains get the tax-free treatment offered by Roth IRAs.

• Rollover to a traditional IRA or qualified retirement plan: With this option, you won’t have to pay taxes on the distribution as long as you complete the rollover within 60 days of the lump sum being distributed. After that, your money will be tax deferred until retirement.

• Rollover to a self-directed IRA (Roth or traditional): The tax implications depend on whether you open a traditional or Roth IRA. But this option gives you the chance to invest in alternative assets, such as real estate, crowdfunding and more.

What Else To Consider

If your pension is frozen, there are other things you should consider while you are readjusting your retirement strategy.

• Other sources of income: Consider your sources of retirement income, such as 401(k) or 403(b) plans, IRAs, home equity, rental property income, other pensions, Social Security and spouse/family income.

• Expenses during retirement: Review your current expenses, and consider costs you may have during retirement, such as rent, mortgage, healthcare, transportation, etc.

• Life expectancy: Your retirement income needs to last the rest of your life. While you can’t predict the future, you can make assumptions based on your age, health and lifestyle.

If you feel confident in your money management skills, opening a self-directed IRA would allow you to use the pension freeze as an opportunity to access a large sum of cash for alternative investments like real estate or private equity/debt. You would then be in control to choose the best investment strategy for your season of life and age.

Modern workers are less likely to spend their career in one company and need a retirement framework with savings that can follow them. Rolling over your pension can lower your tax bill and set you up for a bright retirement future — just don’t forget the rules.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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