July 25, 2019
Can you rollover a Defined Benefit Plan distribution to an IRA? Yes, in fact you can, subject to the specifics below. Note that these rules apply to both traditional Defined Benefit Plan rollovers and Cash Balance Plan rollovers.
When a participant separates from service or an employer terminates their Defined Benefit Plan, the participant may be given the opportunity to receive a payout from the Plan.
The form in which the benefit is paid out will depend on the Plan provisions. For example, larger, corporate Plans often will not provide a single sum distribution option unless the payout is nominal or the Plan is a Cash Balance Plan. Smaller Defined Benefit Plans, on the other hand, typically allow lump sum distributions for all participants. This is especially true for Cash Balance Plans.
If the single sum option is available and elected by the participant, they may continue tax deferral by rolling over the Defined Benefit or Cash Balance Plan distribution to an IRA. Alternatively, the lump sum payout can be received and retained by the participant, in which case, income, and possibly excise, taxes will apply.
To rollover your Defined Benefit Plan benefit into an IRA, you generally must have a distributable event. Examples include separation from service or when the Plan is being terminated.
A Defined Benefit Plan participant can rollover their distribution to an IRA or another employer-sponsored plan.
Employer-sponsored plans include SIMPLEs, SEPs, 401(k)s, Profit Sharing Plans, 403(b) Plans, and governmental 457(b) Plans. Note, however, that the recipient Plan document must allow for rollovers into the Plan.
Once a participant rolls over their distribution to the IRA or employer-sponsored plan, funds are subject to the rights and options of the IRA or Plan where the proceeds are transferred.
With some exceptions, all or part of the amount of the Defined Benefit distribution may be rolled over. That said, amounts subject to required minimum distributions at age 70-1/2 (or age 72) cannot be rolled over. The amount eligible for rollover should be communicated by the Plan at payout.
There are two ways to rollover a Defined Benefit distribution: a direct rollover or a 60-day rollover.
As the name implies, a direct rollover is when the Plan paying the distribution makes a direct transfer to the IRA or employer plan receiving the funds. No withholding is required. This is the simplest and preferred method.
If a direct rollover is not done, the participant receiving the distribution can within 60 days rollover funds to an IRA or employer plan. However, the Plan paying the distribution must withhold 20% of the payout for federal income taxes. The participant would then need to use other funds to rollover the amount withheld. Any amount not rolled over, including for withholding, is subject to both income tax and, if applicable, excise tax. What happens if the 60-day window is missed? Generally, no extension is granted, but a waiver to extend the deadline can be requested via a Private Letter Ruling.
Note, if total annual Plan payouts are less than $200, the Plan does not have to allow a direct rollover. However, the participant is still able to do a 60-day rollover and the Plan does not need to withhold for federal income taxes.
By rolling over the Defined Benefit distribution, income tax is deferred; amounts not rolled over, on the other hand, are immediately subject to federal income tax.
What’s more, participants under age 59-1/2 are generally subject to an additional 10% excise tax for any amount not rolled over. However, the excise tax doesn’t apply in all instances. For example, the excise tax is waived if the participant is at least 55 years old in the year they separate from service. The additional tax also is waived when the distribution is due to death, disability, or a court-ordered decree for the Plan to divide property in a divorce. A number of additional exceptions not listed here may apply.
Once the participant rolls over the Defined Benefit payout to an IRA, some of the exceptions above are no longer applicable. For instance, the age 55 or court-ordered decree exceptions do not apply. However, additional exceptions are applicable. These exceptions are related to higher education, a first-home purchase, and unemployment.
Rules related to State income taxes are not covered here.
The CARES Act provides special tax rules for retirement distributions paid to participants affected by the Coronavirus.
To qualify, the distribution, taking into account all other 2020 retirement payouts, must be under $100,000. Additionally, the participant or their spouse/dependent must have been diagnosed, using an approved test, with COVID-19. A participant also qualifies if they have experienced adverse financial consequences due to the COVID-19 outbreak (e.g., quarantine, furlough, layoff, reduced work hours, lack of childcare, their business closes or has reduced hours).
If the payout threshold and participant criteria are met, the CARES Act provides temporary tax relief. Specifically, the 10% excise tax for early distribution, mentioned previously, is waived. Additionally, the participant may opt-out of the 20% required withholding for lump sums not rolled over and evenly spread the related income taxes over a three-year period. The participant also may repay all or part of the distribution to an employer-sponsored Plan or IRA such that the payout is recharacterized as a rollover rather than a taxable distribution.
State taxes are not impacted by the CARES Act, but states may provide their own tax relief.
Rather than rolling over a Defined Benefit distribution to a Traditional IRA, the participant may transfer the payout to a Roth IRA.
Roth IRAs are generally not subject to income tax at payout. As a result, the entire Roth rollover is taxed at the time of transfer. In this case, the 10% excise tax does not apply unless a distribution from the Roth IRA is taken within 5 years.
In some Defined Benefit Plans, after-tax contributions are required or permitted. These contributions also may be rolled over to an IRA or employer-sponsored plan. Since after-tax contributions were already taxed, they need to be tracked separately so they are not taxed a second time.
If a Defined Benefit payout is received due to the Plan participant’s death, amounts not rolled over are generally subject to taxation.
When the payout is made to a surviving spouse, the same rollover options available to the participant apply. However, these IRA rollovers can be treated as either the surviving spouse’s or an inherited IRA. If the IRA is treated as the surviving spouse’s IRA, the rules related to early payout and required distributions apply based on the surviving spouse’s age. When the IRA is treated as an inherited IRA, there is no excise tax for early payout, but required distributions must continue if already in payment or must start based on the participant’s age.
If payout after death is made to someone other than the surviving spouse, the only option is to do a direct rollover to an inherited IRA.
A spouse or former spouse may receive a Defined Benefit payout as a result of a court-ordered decree. In this case, generally, the same rollover rules apply. However, the excise tax for early distribution is not applicable.
If a non-resident alien, does not do a direct rollover, the Plan generally must withhold 30%, rather than 20%, of the payout for federal tax purposes. If the withholding exceeds the amount of tax owed, the refund may be requested as described in IRS Publications 519 (U.S. Tax Guide for Aliens) and 515 (Withholding of Tax on Nonresident Aliens and Foreign Entities).