Can a Cash Balance Pension Plan Be Rolled Over to a Roth IRA?

Preparing for retirement can seem daunting when you go it alone, but a pension plan is one way an employer can really help an employee have a comfortable future in their senior years. There are numerous types of defined benefit plans but the cash balance pension plan is the most popular of them all. Although it is an appealing option during your employment, it might be advantageous to roll over this type of account into a Roth IRA at some point.

Read More​: Pension Roll Over Rules

Advantages of a Cash Balance Pension Plan

Employees can really appreciate a cash balance pension plan for several reasons. For starters, employees are not required to contribute any amount of their pay such as in a 401(k) plan. The contributions are made by the employer and are based on a pre-determined amount or percentage of the individual employee's salary. In addition, the funds deposited in the account are protected by the Pension Benefit Guaranty Corporation.

The advantages are not just for employees; cash balance pensions can also be beneficial for employers. Business owners use these types of plans to heavily increase their annual tax-deductible contributions. When decreasing their taxes, they themselves accrue more wealth for their own retirement.

Disadvantages of Cash Balance Pension Plan

"Make your money work for you" is a common phrase when referring to investing. With countless ways to save and invest for retirement, it is important to know both the pros and cons of the different plans. When your employer offers a cash balance pension plan, you might find the numbers appealing, but there are negatives to these types of defined benefit plans.

  • For starters, you have zero control over the funds. In comparison to a 401(k), where an employee can move money around within the plan's funds, a cash balance pension plan is entirely controlled by the employer.
  • These types of plans are considered back-loaded with their funding. This means that the bulk of the contributions come later in the employee's career, closer to retirement. In today's career climate, this is not a good thing because most employees are not staying with their employers for life such as previous generations. This means meagerly-accrued funds in the first several years won't add up to much for retirement years.
  • Federal regulations require certain things of the employers and employees when maintaining a retirement fund. One requirement is employee vesting. This is a set amount of time that an employee must stay with a company just to keep the funds deposited into the pension plan. Many times, this makes an employee stay on board even if they aren't satisfied with their occupation. Conversely, the employee can be out of retirement funds if they leave before the vested amount of time.

Details of a Cash Balance Pension Plan Rollover

You can roll over a cash balance pension plan to a Roth IRA but only if the receiving account allows it. There are certain restrictions placed on a cash balance pension plan rollover. As with most retirement plans, the IRS does not allow any withdrawals without taxation until retirement age. However, because a Roth IRA is defined by pre-taxed deposits, you'll need to pay the taxes on the funds in the pension plan before rolling it over to a Roth IRA.

These are the steps to rolling it over to a Roth IRA:

1. Research and establish a Roth IRA that will allow the funds from your pension plan to be rolled over.

2. Cash out the funds in the defined benefit plan and pay income tax at the end of the calendar year (the amount withdrawn contributes to your overall income for the year and will be taxed according to your tax bracket).

3. Once the cash is in the Roth IRA, you may begin to move the funds around between different investments that the Roth IRA allows.

Things to Note for Cash Balance Pension Plan Rollovers

The most important things to remember when considering a cash balance pension plan rollover are the tax laws surrounding the transaction. A Roth IRA is funded with after-tax money, so you must pay taxes on the pension funds in order to deposit them.

Another thing to keep in mind about the pension before cashing it out is that, although the IRS does not have a time allotted for vesting individuals in a cash balance pension plan, it would be smart to leave it in for at least three years as a standard minimum and aim for the five-year mark. The same applies to an employer who wants to transfer the pension plan to an IRA for employees.

Read More​: What Does Vested Mean?