Can a Lump Sum Pension Be Rolled Over Into an IRA?
Original post by Ciaran John of Demand Media
You can roll a lump sum distribution from a pension plan into an individual retirement arrangement (IRA). When you rollover your pension funds, you avoid having to pay taxes although you do eventually have to pay income tax when you make a withdrawal from the IRA. Typically, you cannot take a lump sum withdrawal from a pension until you reach the age of 59 1/2 or until you leave your job. However, federal laws do not require pension plan custodians to include provisions that allow for lump sum distributions so some employers do not allow you to make such withdrawals.
SIMPLE IRAs, 403b plans and 401ks are all types of defined contribution pension plans. When you participate in these plans, you and your employer can invest money into the plan but your returns are subject to the performance of the account over the duration of the investment term. You can usually take a lump sum withdrawal from a defined contribution plan. Some employers sponsor defined benefit plans that typically take the form of annuities. In these plans, you are assured of receiving a future income benefit. Many companies do not allow you take take lump sum withdrawals from defined benefit plans in which case you have to wait until you retire to receive your benefits in the form of monthly income payments.
If you and your employer fund your pension on a pre-tax basis, you can roll your lump sum pension into a traditional IRA since these accounts contain pre-tax funds. Some employers allow you to make after tax contributions into Roth 401ks or Roth 403bs. You can roll funds from Roth pension plans into Roth IRAs since these self-directed retirement accounts are also funded with after-tax money. Different rules apply to SIMPLE IRAs, which are pension plans available through employers with no more than 100 employees. You cannot make after-tax contributions to SIMPLE IRAs. Additionally, you cannot roll funds from a SIMPLE IRA into traditional IRA unless you have held the SIMPLE IRA for two years or more.
You do not pay any taxes if your employer directly transfers your lump sum to your IRA. If you physically take possession of the lump sum proceeds, your employer has to deduct 20 percent of your disbursement and use this money to cover your federal taxes on the withdrawal. The IRS refers to this mandatory tax deduction as a withholding. You have 60 days to deposit the rest of the proceeds into an IRA and you also have to replace the 20 percent that your employer withheld with your own money. You eventually get the withholding back at the end of the tax year, but only if you complete the rollover.
You have to pay a 10 percent premature withdrawal penalty if you withdraw money from a pension plan when you are younger than 59 1/2. Therefore, you pay this penalty plus income tax if you fail to complete a rollover within 60 days of receiving the lump sum. The taxes and penalty do not apply to after-tax contributions you make to a Roth pension plan. When you roll a lump sum, you lose any pension funds that have not been vested. The IRS uses the term "vested" to describe money inside your pension that belongs to you. Employers can use vesting schedules that cause employer contributions to become completely vested seven years after funding the account.
- United States Department of Labor: What You Should Know About Your Retirement Plan
- American Funds: Rollover Options
- United States Department of Labor: FAQs About Pension Plans And ERISA
- IRS.gov; Topic 412 - Lump--Sum Distributions; March 2011
About the Author
Ciaran John began writing in 1994 with contributions to "The Hourly Press" and "The Sawbridgeworth Observer." He holds a Florida Life, Health and Variable Annuity license as well as series 6 and 63 securities licenses. He has a Bachelor of Arts in theology from Kings College in London.