Can You Roll a Pension Into a 401k?

Moving funds from a pension into a 401(k) plan is a common question when managing retirement savings. Understanding how retirement funds can be transferred is important for financial planning and maintaining tax benefits. This process involves specific rules and distinctions between different types of retirement accounts.

Types of Retirement Plan Rollovers to a 401k

Retirement plans fall into two main categories: defined benefit (DB) plans and defined contribution (DC) plans. A defined benefit plan, often called a pension, typically promises a regular payout during retirement based on factors like years of service and salary. In contrast, a defined contribution plan, such as a 401(k), involves contributions into an individual account, with the retirement benefit depending on investment performance. A traditional defined benefit pension itself cannot be directly rolled into a 401(k).

A rollover to a 401(k) is possible if the defined benefit plan offers a lump-sum distribution option upon separation from service or plan termination. This lump sum represents the commuted value of the pension benefit, which can then be transferred. Other defined contribution plans, like a 401(k) from a previous employer or a 403(b), are eligible for direct rollovers into a new employer’s 401(k), provided the receiving plan accepts such transfers.

There are two primary rollover methods: a direct rollover or an indirect rollover. A direct rollover, also known as a trustee-to-trustee transfer, involves funds moving directly between plan administrators without passing through the individual’s hands. This method is preferred because it avoids mandatory federal income tax withholding of 20% that applies to distributions paid directly to an individual from an employer-sponsored plan.

An indirect rollover occurs when funds are distributed to the individual, who then has 60 days to deposit the money into a new qualified retirement account. If the entire amount, including any withheld taxes, is not redeposited within this 60-day window, the distributed amount becomes taxable income and may be subject to an additional 10% early withdrawal penalty if the individual is under age 59½. The 20% mandatory withholding means an individual may need other funds to roll over the full distribution.

The Rollover Process

Initiating a rollover begins by contacting the administrators of both the distributing and receiving 401(k) plans. Gather specific information, such as account numbers and personal identification details, necessary for the transfer. The distributing plan administrator can provide instructions and required forms for a distribution.

Individuals must complete various forms, including distribution request forms from the old plan and rollover acceptance forms from the new 401(k) plan. If choosing a direct rollover, instructions ensure funds transfer directly between plan administrators. For an indirect rollover, funds are issued to the individual, who must deposit them into the new 401(k) within the strict 60-day timeframe to avoid tax consequences.

Once forms are accurately completed and necessary documentation gathered, submit them according to plan administrators’ instructions. This may involve mailing physical forms or utilizing online portals. After submission, obtain confirmation of the transfer to ensure funds have successfully moved to the new 401(k) account.

Important Factors for Your Decision

Before deciding to roll over a lump sum from a pension or other eligible funds into a 401(k), several factors warrant consideration. The investment options available within the new 401(k) plan are a significant aspect, as they may differ from the previous plan or other alternatives like an Individual Retirement Account (IRA). Most 401(k) plans offer a selection of mutual funds, including stock, bond, and target-date funds, with some also providing exchange-traded funds (ETFs).

Fees associated with the new 401(k) can impact overall returns over time. These can include administrative fees, investment management fees, and individual service fees. While fees can range from approximately 0.2% to 5% of assets, the average often falls around 0.97% or 1% annually. Evaluating and comparing these costs against the old plan or other retirement savings vehicles is a prudent step.

Understanding the withdrawal rules and access to funds is crucial. Generally, 401(k) withdrawals before age 59½ may incur a 10% early withdrawal penalty, in addition to regular income taxes, unless an exception applies. Required Minimum Distributions (RMDs) typically begin at age 73, mandating withdrawals from the account.

Creditor protection is another consideration, as 401(k) plans generally offer strong federal protection under the Employee Retirement Income Security Act (ERISA). This protection can shield assets from creditors in various situations, including bankruptcy. Some 401(k) plans also allow for loans against the vested account balance, typically up to 50% or $50,000, whichever is less, with repayment usually required within five years.