Can a Pension Be Rolled Into a 401(k)?

Pension plans used to be the most popular retirement savings method but have mostly been replaced by defined contribution plans like 401(k)s. A pension plan requires an employer to contribute to a pool of funds set aside for its employees’ future benefit. The collection of funds is invested in various funds on the employees’ behalf, and the investments grow and generate income that employees can use during retirement. But can a pension be rolled into a 401(k)?

A pension can be rolled into a 401(k) or an IRA so long as the pension is classified as a "qualified employee plan." Additionally, you must have the company, or your company must be planning on terminating the pension plan in order before rolling over the funds to a 401(k).

Knowing how to properly roll over a pension can help save you from paying early withdrawal penalties and delay your tax obligations.

When will you need to roll over a pension into a 401(k)?

When you leave an employer, it’s essential to make a note of the retirement plans you have with that company. Too many pensions and 401(k)s are left behind. This leads to unclaimed retirement funds that would otherwise be properly managed in an active 401(k) or IRA.

The two times you’re eligible to roll over a pension into a 401(k) or IRA is when you leave a company, or the company announces they are terminating their pension plan.

In this case, your employer will give you the option to receive your pension funds in a lump-sum distribution or to roll over the funds into a retirement account of your choosing.

Rules on lump-sum pension payouts.

If you are over 55, you can take out a lump-sum distribution from your pension when you leave, or the plan is terminated and not face a 10% penalty tax from the IRS. This rule differs from distribution limitations placed on 401(k)s and IRAs. Typically, you'd be on the hook to pay the 10% penalty on most distributions taken before 59½. So if you roll over your pension into a 401(k), you’ll have to wait until you turn 59½ before you can take out the funds penalty-free.

However, if you roll over your pension into a 401(k) or another eligible retirement account when you quit, you’ll avoid any penalties. Additionally, your retirement funds will continue to be tax-deferred.

There are two ways to roll over a pension to a 401(k).

When an employer announces they are terminating the company’s pension plan, they will offer employees a lump-sum distribution. The same goes for employees who leave a company with a vested balance in their pension fund.

The IRS allows employees to roll over their pension distribution into a 401(k) and IRA and avoid any income tax obligations at that time and any early withdrawal penalties.

There are two ways you can roll over a pension to a 401(k): a direct rollover and an indirect rollover.

Direct rollover

The easiest way to roll over a lump-sum pension distribution to a 401(k) is through a direct rollover. You’ll need to have a 401(k) account already set up in order to do a direct rollover.

First, you'll need to work with your employer and provide the necessary information to initiate a distribution from the pension plan. The pension plan’s administrator will facilitate the direct transfer of funds from the pension account to your 401(k). Everything is done for you within a couple of business days.

Indirect rollover

If you don’t have a 401(k) already set up, you can still roll over your pension funds to a 401(k). You can elect to have the entire pension funds balance sent to you via check.

The only rule is that you must deposit the funds into a 401(k) within 60 days, or the distribution will be considered a retirement withdrawal and be subject to income tax—possibly a penalty if you are under 55.

When you take indirect rollover, the pension plan administrator is required to withhold 20% of the account balance for tax purposes. However, the IRS rules say you must roll 100% of the pension amount into the 401(k) to avoid paying taxes and penalties. To prevent this, you will need to make up the extra amount from another source, such as a savings account, to complete the rollover in full. The 20% your employer initially withheld will then offset your tax obligations for that tax year.

Bottom line.

When it comes to rolling over pension plans or rolling over old 401(k)s, it’s essential to keep tabs on your various retirement funds. If you leave companies, take your retirement plans with you. This helps keep all of your precious retirement funds together where you can more easily manage them.