How to Combine Pensions and Retirement Accounts

Combining retirement accounts can simplify financial management for individuals who have accumulated multiple accounts from various employers over their careers. This consolidation streamlines record-keeping and potentially reduces administrative complexities. Many people find themselves with scattered retirement savings as they change jobs, making it beneficial to explore options for bringing these assets together.

Understanding What Can Be Combined

Retirement plans fall into two main categories: defined benefit (DB) and defined contribution (DC). A defined benefit plan, or traditional pension, promises a specified monthly income at retirement based on factors like salary and years of service. A defined contribution plan, such as a 401(k), 403(b), or 457(b), involves regular contributions, with the retirement benefit depending on total contributions and investment performance. The employer bears the investment risk in a defined benefit plan, while the employee assumes this risk in a defined contribution plan.

Combining a traditional defined benefit pension usually means taking a lump-sum distribution option, if offered, and rolling it into an Individual Retirement Account (IRA) or another eligible retirement plan. For defined contribution plans, combining typically involves rolling over funds from an old employer’s 401(k), 403(b), or 457(b) into an IRA or the retirement plan of a new employer. Most employer-sponsored plans and IRAs are eligible to receive such rollovers, maintaining their tax-deferred status. This consolidation allows for centralized management of retirement assets.

Key Considerations Before Combining

Before combining retirement accounts, evaluate several factors to ensure the decision aligns with your financial goals. Review existing plan rules, including vesting schedules, withdrawal restrictions, and associated fees. Some plans may offer unique investment options or features that could be lost upon transfer.

For defined benefit plans, spousal consent may be required before a lump-sum distribution or rollover. This protects a spouse’s right to a potential survivor annuity. Converting a guaranteed pension income into a potentially volatile investment account requires assessing personal risk tolerance and financial security needs.

Research the receiving account or plan, whether it is a new employer’s plan or an IRA. Consider administrative fees, available investment choices, and the level of creditor protection offered. Employer-sponsored plans, like 401(k)s and pensions, generally have strong creditor protection under federal law, such as the Employee Retirement Income Security Act (ERISA). IRAs offer some protection under federal bankruptcy law, but may have varying levels of protection from other creditors depending on state laws.

Understanding the distinction between a direct rollover and an indirect rollover is also important. A direct rollover transfers funds directly from one financial institution to another, without the money passing through the account holder’s hands. An indirect rollover means funds are paid directly to the individual, who then has 60 days to deposit the money into another eligible retirement account. The choice between these methods has significant tax implications, which should be understood before proceeding.

The Process of Combining Retirement Accounts

The process of combining retirement accounts begins by identifying the accounts to be consolidated and the receiving account. Next, contact the administrator of the account from which funds will be moved. This could be a former employer’s human resources department or the financial institution managing the old retirement plan.

The plan administrator will provide the necessary forms and instructions for requesting a rollover or transfer. These forms often require specific details about the receiving account, including the financial institution’s name and the new account number. It is advisable to specify a direct rollover, where funds are sent directly from the old plan to the new account custodian. This method helps avoid potential tax withholding and penalties.

If a direct rollover is chosen, the old plan administrator will typically issue a check payable to the new account custodian, or wire the funds electronically. This check might be mailed to the individual to forward, or sent directly to the new financial institution.

In situations where an indirect rollover occurs, the individual receives the distribution check directly, made payable to them. Deposit the entire amount into another eligible retirement account within 60 calendar days to avoid the distribution being considered taxable income and potentially subject to penalties. After the transfer, confirm with the receiving institution that the funds have been successfully deposited.

Tax Implications of Combining

Combining retirement accounts through a rollover is generally a tax-free event, provided the transaction adheres to IRS rules. When funds move directly from one qualified retirement plan to another, or to an IRA, no immediate income tax is due. This principle applies to direct rollovers, where the money is never in the individual’s direct possession.

However, if an indirect rollover is performed, where funds are paid directly to the individual, a mandatory 20% federal income tax withholding typically applies to the distribution from employer-sponsored plans. Even with this withholding, the individual must deposit the full distribution, including the withheld 20%, into the new retirement account within the 60-day deadline to avoid taxes and potential penalties. If the full amount is not redeposited, the portion not rolled over, including the withheld amount, becomes taxable income.

Failure to complete an indirect rollover within the 60-day period results in the distribution being considered a taxable withdrawal. If the individual is under age 59½, an additional 10% early withdrawal penalty may also apply, unless an exception is met. For rollovers from a traditional pre-tax account to a Roth IRA, the amount rolled over is considered taxable income in the year of the conversion, as Roth accounts are funded with after-tax dollars.

Regardless of the rollover method, the distributing institution will issue IRS Form 1099-R, titled “Distributions From Pensions, Annuities, Retirement, or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.” This form reports the gross distribution and indicates whether the rollover was direct or indirect through specific codes in Box 7. It is the individual’s responsibility to report the rollover correctly on their federal income tax return to demonstrate that the distribution was a tax-free rollover.