If you have a traditional defined benefit pension plan Where you work, you may have the option to receive this money in a lump sum when you leave your job or retire. One option is to transfer your pension funds to a Roth Individual Retirement Account (IRA). Learn the pros and cons of rolling your pension into a Roth IRA.

Transferring a Pension to a Roth IRA: An Overview

The two main types of employer retirement plans include a defined contribution plan and a defined benefit plan, commonly known as a traditional pension.

Defined contribution plan

With a defined contribution plan, such as a 401(k) or a 403b)you pay money from your salary and your employer can match part of your contributions. With a defined contribution plan, you decide how the money will be invested, within the range of choices offered by the plan.

Defined benefit plan

With a pension or defined benefit plan, your employer funds the plan and promises you a certain benefit when you retire, usually based on your salary and years of service. Your employer makes investment decisions and is responsible for paying promised benefits.

Quit your job

When you leave your job, you can usually take the money from your defined contribution plan with you. However, you may not be able to take your defined benefit plan with you unless your employer’s plan rules allow it. When you retire, your defined benefit plan may offer you the choice between regular payments for the rest of your life or a lump sum payment.

The amount of lump sum will be calculated based on your age, your interest rates, the value of benefits you would be entitled to in the future and the extent to which you are acquired in the plan.

If you leave your job, you can often turn your pension over to your employer and start receiving monthly benefits after you reach retirement age, unless your employer terminates his retirement plan.

In some cases, you won’t have a choice; If your pension is worth $5,000 or less, your employer is allowed to give it to you in a lump sum, whether you want it or not. This is called a cash withdrawal.

Benefits of rolling your pension into a Roth IRA

Tax-free withdrawals

Once your money is in the Roth IRAyou will benefit from all the tax advantages that a Roth offers. After you’ve held a Roth account for at least five years, your withdrawals will be tax and penalty free as long as you’re age 59½ or older. There are also flexible exceptions to these rules.

More control over investments

With a Roth IRAyou will have control over how your money is invested while your employer makes these decisions about your pension. For example, you can invest more aggressively than your employer, in the hope of a higher return, if you are ready to assume the additional risk.

Easier access to your money

With its flexible exceptions for early withdrawals, you can withdraw money from Roth at almost any time (although there may be taxes and penalties). With your pension, you generally have to wait until at least age 59 1/2 to receive anything. However, some defined benefit plans allow loans.

No Required Minimum Distribution (RMD)

Non-Roth retirement accounts, such as Traditional IRAsare subject to required minimum distributions (RMDs) after reaching age 73 (for people born between 1951 and 1959) or age 75 (for those born in 1960 or later). Your employer’s defined benefit retirement plan may also require that you begin taking distributions at a certain time. In both cases, you will have to pay tax on the money you receive.

A Roth IRA doesn’t require you to withdraw money during your lifetime, allowing you to leave the entire account to your heirs if you want and can afford it.

Disadvantages of rolling your pension into a Roth IRA

You will have to pay taxes in advance

If you decide to ride on your pension capital in a Roth IRA, you I owe income tax about money like you would with any other Roth IRA Contribution. After that, the money in your Roth will grow tax-deferred and be eligible for completely tax-free withdrawals if you follow the rules.

Responsibility to invest

Rather than leaving the burden on your employer, you will be responsible for deciding how to invest the money in your IRA. You can consider this an advantage or a disadvantage, depending on your comfort level. investment management.

No guarantee

When your money is in a retirement plan, your employer promises that you will receive benefits of a certain amount in the future. Even if some employers break their promises for one reason or another, your benefits may be insured by the federal government. Retirement Benefits Guarantee Corporation. However, Roth IRAs have none of these guarantees.

When a Pension Rollover to Roth IRA Makes Sense

If your retirement capital is relatively small, rolling it into a Roth IRA and paying taxes on that money now could be a worthwhile compromise, especially if you’re young and your Roth IRA will have years, or even decades, of growth ahead. him. because that money will then come to you tax-free in retirement.

Consider your tax bracket

With a larger amount, you will have to be more careful. A consideration is your tax bracket. If you roll your pension into a Roth, it may move you into a higher tax bracket for that tax year.

For example, let’s say you are single and your modified adjusted gross income (MAGI) is $100,000 per year. As a result, your highest marginal tax bracket in 2024 is 22%, and that bracket ends at $100,525. The highest tax bracket is 24%. So if you roll over a lump sum of $50,000 into a Roth, you’ll fall into the 22% tax bracket on the first $525 and the 24% tax bracket on the remaining $49,475.

Switch to a Traditional IRA

One way to reduce your tax cost would be to transfer your lump sum into a traditional IRA and convert it in steps into a Roth IRA. You’ll still owe tax on the money you convert, but you’ll have some control over the tax bracket.

With a traditional IRA, you won’t owe any taxes on the rollover as long as you follow the rules of a direct reversal or a 60 day renewal.

In a direct rollover, your pension administrator will transfer the money directly to the financial institution that will hold your IRA or write a check to that institution and give it to you for deposit. The pension administrator will write you the check and you will have 60 days to deposit some or all of the money into the IRA; the trustee will also withhold 20% for taxes. If you miss the 60-day deadline, you will have to pay taxes on the full amount.

However, if you’re close to retirement age, you might be better off either leaving the pension money with your employer or simply rolling it over into a traditional IRA and not converting to a Roth . Either way, you’ll end up paying tax on the distributions you receive, but you might find yourself in a lower tax bracket.

The essentials

If you have a traditional pension at work, you may be able to receive a lump sum when you change jobs or retire. You can then reinvest this money. If you roll it over to a traditional IRAyou won’t have to pay any taxes until you make withdrawals. If you choose a Roth IRA, you’ll have to pay taxes on the money up front, but your future withdrawals may be tax-free. If you decide to go with the Roth, you can reduce the tax impact by first depositing the money into a traditional IRA and convert it to a Roth IRA over a series of years.