Leaving your job not your vested pension: Options & IRA rollovers

As of March 2022, only 15% of private industry workers had access to a defined benefit plan, according to the U.S. Bureau of Labor Statistics. If you're among that small sliver, you likely appreciate that a pension can give you a predetermined, steady stream of income in your retirement years. That's not a benefit you can get with a defined contribution plan like a Simplified Employee Pension or 401(k) plan.

You also likely know the value of staying long enough to reach the full vesting period. That's when you receive all the employer-provided benefits you've earned. Yet, after achieving that milestone, which varies by employer, what happens if you were to leave the company? Rest assured that vested benefits from a traditional pension are yours no matter what, whether you leave an employer by choice or not, and you'll have a few options for what to do with the money.

The set payout is a strong reason to consider keeping your benefits with your existing retirement plan until you can claim them when you turn 65 (or the plan's normal retirement age, if earlier). Also, pension payments are protected against certain creditor claims, which may be important to you.

Your company may require that your pension stays put even if you leave the company before retiring, so start by reviewing your pension plan summary.

If your plan allows it, you may be able to receive an early, lump-sum distribution, receiving the vested value of your pension in cash. However, you could face a tax hit for doing so.

The funds likely will be subject to federal income tax. Also, if you're younger than 59½, you typically face a 10% penalty on the entire withdrawal amount. An exception is if you leave your job in the year you turn 55 or after, in which case the penalty may be waived.

If you're exempt from the 10% penalty and are prepared for the tax consequences, you could consider a combination of a payout (for money in the short term) and rolling over your money to a retirement savings account (for money that could grow over time). But it's more common to consider a full rollover if sticking with your current employer's plan isn't an option.

Pensions often don't provide enough money for retirement, even when paired with Social Security.¹ One reason is the money you receive may not keep up with inflation if your plan doesn't offer a cost of living adjustment.

But having the ability to potentially grow your money in the market over a long period may help you reach your retirement goals more effectively. If your plan lets you receive a preretirement payment, you may be able to roll over a pension to a 401(k), IRA or other tax-advantaged account.

Consolidating your assets into one place could streamline your finances. Meanwhile, a rollover could offer reassurance if you're worried the company may not be able to fulfill its pension obligations when you reach retirement age. (The Pension Benefit Guaranty Corporation insures most private-sector defined benefit plans and guarantees participants their benefits up to certain limits.)

While you'll have a few destinations on offer for rolling over your pension, it's common to see a rollover to an IRA because it offers a number of unique advantages.

Penalty-free access to funds for certain reasons: You can take out money without incurring an early withdrawal penalty for specific nonretirement purposes. These could include purchasing a first home and paying for qualified higher education expenses.

You still can maintain favorable tax treatment: A rollover into a traditional IRA isn't taxable. You pay taxes when you withdraw the money. With a pension rollover to a Roth IRA or a designated Roth account, you pay taxes on the rollover amount, but you don't pay taxes on qualified withdrawals.²

You can own annuities in an IRA: Defined benefit plans typically distribute a pension in the form of an annuity paid over the employee's life (and potentially the life of their spouse). If you like the idea of including annuities in your portfolio, you can hold annuities in an IRA.

You could outlive your money: Investing requires some degree of risk. Though strategies like diversification can help reduce the impact of market volatility and inflation, investments in your IRA may not provide the return you need to cover your expenses.³

You have a lot to consider when you leave a job as a vested participant in a traditional pension. Since plan provisions about distributions vary, check your summary plan description for your options. Some plans even offer a graded vesting schedule in which you can become partially vested over time, which may spark different decisions.

A local financial advisor can help you navigate the complexity. Together you can discuss variables like your age, health status, risk tolerance, existing investments and tax-related considerations to determine what type of pension treatment is right for you.