What to Do With Your Pension When Leaving a Job

When separating from employment, navigating your pension involves decisions that impact your financial future. Understanding your options is important for making informed choices about these retirement savings. This article outlines pension types and choices available when changing jobs.

Understanding Your Pension When Leaving

Pensions typically fall into two main categories: Defined Benefit (DB) plans and Defined Contribution (DC) plans. A Defined Benefit plan promises a specified payment at retirement, often calculated using a formula based on your salary, age, and years of service. The employer bears the investment risk, ensuring the promised benefit regardless of market fluctuations.

In contrast, a Defined Contribution plan, such as a 401(k) or 403(b), involves contributions made by you, your employer, or both, into an individual account. The retirement benefit depends on the amount contributed and the investment performance. The investment risk generally rests with the employee.

A significant concept for both plan types is “vesting,” which refers to the employee’s ownership of employer contributions. Your own contributions are always yours, but employer contributions become fully owned after a certain period of service, known as a vesting schedule. If you leave employment before being fully vested, you may forfeit a portion of the employer’s contributions. You can determine your plan type and vesting status by reviewing plan documents or contacting your former employer’s human resources department or the plan administrator.

Defined Benefit Pension Options

If you have a Defined Benefit pension plan, you generally have several choices when you leave your job. One common option is to take a lump sum payout, which is a single payment representing the present value of your future pension benefits. This option may be offered if your benefit is below a certain threshold.

Another common choice is to receive an annuity, which provides regular payments over a specified period, often for your lifetime. You might select an immediate annuity, where payments begin soon after leaving, or a deferred annuity, with payments starting at a future retirement age. Annuity options can include a single-life annuity, which pays only for your lifetime, or a joint and survivor annuity, which continues payments to a designated beneficiary, typically a spouse, after your death.

A third option is to leave your accrued pension benefit with your former employer, often referred to as a “deferred vested benefit.” This means you will receive your pension payments at a later date, usually upon reaching the plan’s early or normal retirement age.

Defined Contribution Pension Options

For those with a Defined Contribution plan, such as a 401(k), various choices are available upon job separation. One option is to roll over your funds into a new employer’s qualified plan, provided the new plan accepts such rollovers. This can help consolidate your retirement savings.

You can also roll over your funds into an Individual Retirement Account (IRA). This provides flexibility and potentially a wider range of investment options. If you roll over a traditional 401(k) to a traditional IRA, taxes remain deferred; however, rolling a traditional 401(k) to a Roth IRA constitutes a conversion, and the amount rolled over becomes taxable income.

Another choice is to leave the funds in your former employer’s plan, if permitted by the plan rules. This can be a suitable option if you are content with the plan’s investment choices and fees. Finally, you can cash out the funds by taking a direct distribution. This option provides immediate access to the money but has significant tax implications and potential penalties.

Tax Implications of Pension Decisions

Each pension decision carries distinct tax implications. Taking a lump sum payout from a Defined Benefit plan or cashing out a Defined Contribution plan generally results in the entire amount being taxed as ordinary income in the year of distribution. If you are under age 59½, these distributions may also be subject to an additional 10% early withdrawal penalty, unless an exception applies.

Annuity payments from a Defined Benefit plan are taxed as ordinary income as you receive them. Rollovers of Defined Contribution plan funds to a new employer’s qualified plan or a traditional IRA allow your savings to continue growing on a tax-deferred basis. A direct rollover, where funds are transferred directly, avoids immediate tax withholding and penalties.

If you elect an indirect rollover, where you receive the funds directly, your former employer’s plan administrator is required to withhold 20% for federal income tax. You have 60 days to deposit the full amount, including the withheld portion, into an eligible retirement account to avoid taxes and penalties. Required Minimum Distributions (RMDs) are minimum amounts you must withdraw annually from most retirement accounts, generally starting at age 73. Roth IRAs are not subject to RMDs during the owner’s lifetime.

Navigating the Pension Distribution Process

To begin the pension distribution process, contact your former employer’s human resources department or the plan administrator. Request benefit statements and distribution election forms. These documents will detail your accrued benefits, available options, and associated timelines.

Once you have reviewed your options and made a decision, accurately complete the required forms. For a direct rollover, you will need the account details of the receiving institution, such as your new employer’s plan or your IRA custodian. Ensure all personal information, like your Social Security number and contact details, is correct to avoid delays.

After completing the forms, submit them according to the instructions provided by the plan administrator. Keep copies of all submitted documents for your records and confirm receipt. Expect processing times to vary, typically from a few weeks to several months. You will receive confirmation once the transaction is complete.