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If you qualify to receive a pension from your employer when you reach retirement, you have the luxury of extra retirement income -- and the responsibility to manage it. Your employer drafts most of the rules about how you can handle your pension, but if you’re allowed to take a lump-sum payment and cash out your plan, the Internal Revenue Service allows you to roll the cash into a traditional individual retirement arrangement, or IRA.
First determine whether your employer’s pension plan rules allow you to cash out the pension. Some plan managers require pensioners to receive their monthly benefits and don’t offer a cash-out option, while other companies see a lump-sum payment as a way to get a large, and often uncertain, expense off their books. Contact your pension manager to determine your options. If you’re able to take a lump-sum payment, don’t immediately take it. Laying the groundwork for your rollover will spare you problems down the road.
If your pension allows a lump-sum payment, ask if it will facilitate a trustee-to-trustee transfer. This allows the cash from your pension to go directly to your broker without coming into your possession. The transfer can be accomplished by an electronic transfer or by having your pension plan make out the lump-sum check to your brokerage. While this transaction is reported to the Internal Revenue Service, your personal involvement in the transfer is negligible because you never personally hold the funds.
In some cases, your pension manager won’t facilitate a direct rollover from your pension to an IRA. You’re still able to move funds from your pension to an IRA, but you’ll need to be careful when you perform the rollover yourself. The IRS only allows you a 60-day window to move funds from a pension to an IRA. This window includes weekends and holidays, and if day 60 falls on a day that banks are closed, you won’t receive any additional days to make the switch.
If you must make the rollover yourself by securing your pension funds and depositing them to your IRA, the financial consequences of not getting the funds into an IRA by the end of the 60-day period are major. First, the IRS treats the lump sum as regular income, not a rollover, and taxes you at your normal income rate. If your pension is worth a lot, this may push you into a higher tax bracket, making the tax hit even more severe. Secondly, you lose the ability to place the funds into an IRA once the window closes. You can only contribute up to your maximum annual contribution limit, which is $5,000 or $6,000 depending on your age, so the bulk of your pension might remain locked out of your IRA for many years.
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