When you retire with a pension, you typically receive a set payment every month until a certain point, usually your death. Your employer may, however, give you the option to take the entire pension payment as a lump sum, which you then have to invest in another retirement vehicle. If you think the growth potential of the stock market outweighs the upfront taxes you'll have to pay, investing your lump-sum pension in a Roth individual retirement account might be the way to go.
Almost 40 percent of all U.S. households are invested in individual retirement accounts, according to a 2011 Investment Company Institute report. Many of those accounts exist because workers rolled over the benefits from an employer-sponsored plan into an IRA. IRAs are popular because taxes are deferred on the money being rolled over. With a Roth IRA, you'll have to pay income tax on the amount you rolled over in the year that the transaction occurred. Once you pay income tax on the amount, however, the money in a Roth won't be taxed again even as you begin to draw an income.
While not all employers or plan sponsors offer employees the lump-sum option for pensions, more of them are offering this choice. In some cases, employers have extended the lump-sum option to plan members even after they've retired and started collecting their monthly income checks. Presuming your employer offers a lump sum, alert your plan administrator that you will be choosing this option. Prepare for your forthcoming payment by opening up your IRA either at your local bank, brokerage office or mutual fund firm. When you receive your lump-sum pension check in the mail, the last thing you want to do is hold onto it, as tempting as that might be. You only have 60 days to direct the money into your Roth IRA account or it will be considered a withdrawal.
To take full advantage of the benefits associated with a pension rollover, you'll have to meet some conditions. To be entitled to all of your pension benefits, you must be fully vested in the plan. This means that you must work for your employer for at least five years, although partial vesting that entitles you to partial retirement benefits may be allowed. If you change jobs, you're entitled to the amount of your pension in which you are vested but even then you can't access the money for a rollover until you turn 65. Some employers allow you to retire at 55 but you'll have to settle for a smaller pension benefit.
Investing and Contributing
Tax benefits aside, you're going to have some work to do with an IRA. When your money was with your employer, it took the liberty of investing the funds for you. Once the money is rolled over, you'll be responsible for investing the savings in such a way that it will continue to grow and last for the rest of your life. Also, if you want to make deposits into your Roth IRA to help increase the size of your savings, you're only allowed to contribute $5,500 per year or your taxable income -- whichever is less -- as of 2013. If you're over the age of 50, however, a "catch-up" clause allows you to contribute an additional $1,000 per year.
Rollover is Only Option
If you want to put your pension money into a Roth IRA, a full rollover is the only option. The Internal Revenue Service requires that contributions to any IRA account come only from earned income, which means you are not allowed to contribute to a Roth IRA from your monthly pension checks.
- USA Today: Investing: Young? Working? Start a Roth IRA. Here's How
- Investment Company Institute: The Roll of IRAs in U.S. Households' Saving for Retirement, 2011
- CNN Money: How Does Vesting Work?
- CNN Money: When Can I Access My Pension Money?
- CNN Money: Your Pension -- Lump Sum vs. Monthly Payments
- Internal Revenue Service: Retirement Topics -- IRA Contribution Limits
- Smart Money: Rolling Over Retirement Accounts
- Internal Revenue Service: Like Share Print Retirement Topics - Rollovers of Retirement Plan Distributions
- Kiplinger: Making Roth IRA Contributions in Retirement
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