Can a Pension be Rolled Over to a 401(k)?
Like many retirement plans, you can roll over a pension into a 401(k) — provided the pension plan is considered a qualified employee plan. As another rollover option, you can also roll over a traditional pension plan to an IRA under the same guideline.
To be considered a qualified employee plan, a pension plan:
- Meet IRS requirements in both form and operation
- Must comply with ERISA requirements (Employee Retirement Income Security Act of 1974)
- May allow employee and employer contributions
Most 401(k)s, 403(b)s, profit-sharing plans, and other employer-sponsored retirement accounts are considered qualified employee plans. For more information about which plans are and are not considered qualified, check out the IRS page on common qualified plan requirements.
To be eligible for a pension plan rollover, you must have either separated from your employer, or the company must have terminated the pension plan, rendering it inactive.
Rolling over your dormant retirement funds — especially if you’re not receiving the value or service you think you should be — can make a lot of sense with regard to retirement planning.
If you’re having trouble locating your old employer’s 401(k), try our free 401(k) finder tool today. You can also try finding your account using your Social Security number.
When Should You Roll Over Your Pension to a 401(k)?
Keeping track of retirement plans from previous employers not only makes managing your financial planning easier from a logistical perspective, but it also can save a ton of money.
Much of our own research indicates that leaving money in a dormant retirement plan can cost an individual investor up to $700,000 over their lifetime—this is primarily due to excessive fees and suboptimal investment options.
As mentioned, the two times you’re eligible to roll over a pension into a 401(k) or IRA (Individual Retirement Account) is if:
- You separate from your former employer, or
- Your company terminates their pension plan
If either of these events happen, you can either take a lump-sum distribution of your defined benefit plan (which will come with ordinary income tax and possibly early withdrawal penalties) or you can roll it over into a retirement account of your choosing.
As with any major financial decision, consider working with a qualified financial advisor before making a choice about what to do with your retirement savings.
Rules on Lump-Sum Pension Payouts
If you’re at least 55 years of age, and you separate from your employer, or your pension plan is terminated, you’re eligible to receive a penalty-free lump sum distribution of your pension benefits. Note that any withdrawals will still be included in taxable income for the year you take them.
The keys to avoiding the 10% early withdrawal penalty are your age (must be at least 55, according to the Rule of 55) and the circumstances surrounding your pension plan (you must have left your employer or the pension plan must have been terminated).
If you take a lump-sum payout from your pension plan and either or both of these conditions have not been met, you’ll face a 10% early withdrawal penalty on the entire distribution, plus ordinary income tax. Ouch!
On the other hand, if you decide to roll your qualified employee pension plan to another retirement account, like a tax-deferred 401(k) or traditional IRA account, you’ll be able to preserve the account’s tax status and avoid the early withdrawal penalty altogether. The IRS considers this a tax-free rollover, as you’re really just moving money between financial institutions—not taking it as a withdrawal.
If you do opt for a pension rollover, always make sure that you roll your pension into another account with the same tax status (i.e., a pre-tax pension plan to a pre-tax 401(k), or a Roth pension plan to a Roth IRA). Rolling over a pre-tax pension plan to a Roth IRA can cause major tax problems, so be careful!
One additional caveat: Rolling over a pension plan into an IRA means waiting until you turn 59½ before taking out funds penalty-free, as the Rule of 55 doesn’t apply to IRAs. IRS rules around qualified plans can be tricky, so be sure you understand the tax implications of any financial decision before you proceed.
Direct Rollover vs. Indirect Rollover
There are two ways to roll over your pension plan: a direct or an indirect rollover. With a direct rollover, funds transfer from one financial institution to the other without ever entering your hands; the funds move “directly” from one provider to another.
Performing a direct rollover is the easiest way to roll over a lump-sum pension distribution to a 401(k) or an IRA. In most cases, the IRS sees a direct rollover as a tax-free event, and you should face no taxes or penalties, assuming the rollover is done correctly.
To effect a direct rollover, you’ll need to contact your pension plan’s administrator and have them issue a transfer to a receiving account of your choice. Make sure to have all information for the receiving account before making contact with your pension plan administrator, since it’s likely they’ll need at least some of it (i.e., new account number, new account type, etc.)
With an indirect rollover, you’ll receive your pension plan funds as an individual. In other words, you’ll receive a check made out to you directly, or you’ll receive an electronic transfer right into your bank account. The rest of the rollover is then your responsibility: you’ll need to re-deposit the funds into another retirement account (like a 401(k) or an IRA) within 60 days.
If you fail to do this, you’ll be hit with both ordinary income tax (since the plan balance will be included as taxable income) and an early withdrawal penalty (10%) on your entire pension balance. This can amount to a financial catastrophe if you’re not careful, so ask for an indirect rollover only if you’re absolutely sure you can re-deposit the entire pre-tax pension plan account balance to a new retirement account within the IRS-designated timeframe.
The bottom line: if you’re going to engage in a 401(k) or IRA rollover of any kind, opt for a direct rollover when possible.
Need Help Managing Rolling Over a 401(k) rollover?
The benefits of rolling a pension plan to a 401(k) can be significant: you’ll consolidate your retirement funds, you’ll have more control over your investments, and you can make your own decisions about how and when to retire.
If you wait until retirement to roll over your pension plan, you could be losing out on valuable time during which your pension plan could have been invested properly or at a far lower cost.
It’s generally best to work with your pension provider directly, who will be able to walk through their plan-specific rules and how a pension rollover could impact your benefits for retirement.
Capitalize acts as a trusted partner to help aspiring retirees achieve their rollover and retirement savings goals. In fact, we’ve already helped thousands of people successfully roll over their old 401(k)s.
Click here to get started or browse our resources page to learn more about how we can manage the 401(k) rollover process for you!
