A rollover is a tax-free transfer of funds. The idea behind a pension rollover is to move retirement money from one plan to another without taxes while maintaining its cost basis (i.e., premiums and taxed contributions). Most pension plans are qualified, meaning they can be rolled over tax-free to another qualified plan. Non-qualified plans cannot be rolled into qualified ones, but you may be able to transfer them tax-free to other non-qualified plans.
Qualified vs. Non-Qualified Plans
A qualified retirement plan conforms to the rules set out in the Employee Retirement Income Security Act, or ERISA. Qualified plans provide important tax benefits, such as tax-deferred growth and possibly the postponement of taxes on employee contributions. Examples of qualified plans include 401(k)s and 403(b)s. You can roll over one qualified plan to another or to an IRA or SIMPLE plan without triggering taxes and without restrictions on the amount.
Read More: Are IRA Accounts ERISA Qualified?
Non-qualified plans are usually set up for high-paid executives, possibly to supplement a company’s qualified plans. Plans may be funded by the employer, the employee or both. They include executive bonus plans, 409A deferred compensation plans, split-dollar life insurance plans and group carve-out plans. Employee contributions to these plans are made with after-tax dollars. Deferred compensation is not taxed until received.
Lump-Sum vs. Annuity
You can receive the proceeds of a non-qualified pension plan as an annuity and/or lump-sum distribution. In a lump-sum distribution, you receive your money all at once, whereas annuities spread out distributions over either a defined period or your remaining lifetime.
Read More: Annuity Vs. Pension
Only untaxed amounts are taxable income when received, protecting employees from paying taxes twice on the same income. Untaxed amounts include employer contributions and any tax-deferred growth. IRS rules determine how taxes will be calculated when your distribution contains a mix of taxed and untaxed money.
Section 1035 Transfers
Many non-qualified plans take the form of life insurance policies, possibly with riders for disability and long-term care benefits. Other plans may include annuity contracts with substantial death benefits.
Under Section 1035 of the Internal Revenue Code, you are allowed to transfer tax-free an insurance policy to another insurance policy or to an annuity. You can transfer an annuity to another annuity but not to an insurance policy.
You can consider 1035 transfers to be rollovers because they are tax-free. However, if you cash out your annuity or insurance policy and use the money to buy a new one, you’ll face the tax consequences of a lump-sum distribution.
Read More: Can I Change My Annuity to a Mutual Fund?
Pros and Cons of Non-Qualified Plans
Non-qualified plans offer several advantages, including unlimited contributions, postponement of taxes on deferred wages, insurance benefits and freedom from ERISA restrictions.
On the minus side, you can lose the money in your non-qualified plan if your employer goes bankrupt or if you are sued by a creditor. In addition, you could forfeit your plan if you do not complete your tenure with your employer or otherwise satisfy the terms of the plan. This creates “golden handcuffs” that may tie you to a job when you’d rather leave.
Non-Qualified Retirement Plan Rollover
Non-qualified pension plans are private contracts between an employer and employee, not subject to federal regulations or protections. This gives employers great latitude when setting up non-qualified plans. In some cases, the employer may allow a non-qualified retirement plan rollover (such as a deferred compensation plan) to another plan without triggering taxes.
You won’t be able to roll over a lump-sum distribution from a non-qualified plan when you leave the company. However, your contract may allow you to take your distribution as an annuity, spreading out the tax liabilities (if any) over an extended period. Because non-qualified plans may be worth millions of dollars to top executives, it's prudent to work with an expert, such as an accountant or a tax attorney, when negotiating your participation in a non-qualified plan.
Eric Bank is a senior business, finance and real estate writer, freelancing since 2002. He has written thousands of articles about business, finance, insurance, real estate, investing, annuities, taxes, credit repair, accounting and student loans. Eric writes articles, blogs and SEO-friendly website content for dozens of clients worldwide, including get.com, badcredit.org and valuepenguin.com. Eric holds two Master's Degrees -- in Business Administration and in Finance. His website is ericbank.com.