Can a Defined Benefit Plan be Rolled Over Into an IRA or 401(k)?

Defined benefit plans have become very popular recently with small business owners. But questions persist. Specifically, can a defined benefit plan be rolled over into an IRA or 401(k)?

Thanks to tax reform, defined benefit plans are becoming increasingly popular. But numerous questions persist over the distribution rules. The most important of which is – can a defined benefit plan be rolled over into an IRA? Let’s take a close look at the defined benefit plan rollover.

A defined benefit plan is very different from a 401k. The sponsoring company will contribute a percentage of an employee’s salary into an investment account. The company will invest this money and then provide a retirement distribution to the employees upon retirement.

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Some background

Defined benefit plans are great for small business owners because they offer large contributions and significant tax deductions. The one downside of the plans is that you need to meet the IRS permanency rules.

The defined benefit plan also offers flexibility in terms of investment options, allowing the business owner to customize their retirement savings strategy. Lastly, the guaranteed income stream provided by the plan can offer peace of mind, ensuring that the business owner will have a steady income stream in retirement, regardless of market conditions.

The IRS states that a defined benefit plan should be a permanent plan structure. That is, you should go into it with long-term intent and have the plan open for several years.

While the IRS did not define precisely what several years means, you should have long-term intent with a minimum of 3 to 5 years of mandatory contributions.

But what happens when you want to terminate a plan? Can you roll over a defined benefit plan into an IRA or 401(k)?

The defined benefit plan rollover

But circumstances often change. People get concerned that when they set up a defined benefit plan are not allowed to change the plan or even terminate it. As the IRS sees it, the plan is permanent in nature and cannot be randomly terminated for an invalid reason.

The IRS simply assumes the plan will last indefinitely. But it is typically acceptable to the IRS to terminate the plan as long as it is in existence for at least a “few years.”

However, the tax code is somewhat vague. It doesn’t specifically define what a “few years” means. The IRS states that the plan can only be terminated if and when there is a business necessity to do so.

A business necessity most likely exists when the company has lower cash flows or profits, there is a significant change in ownership, or there is a material event that prevents or inhibits its ability to fund the plan on an ongoing basis. The IRS will normally allow the company to adopt a substitute or alternate plan as a reasonable cause for plan termination. This is also the case for a solo plan.

From a mere practical standpoint, the IRS will generally not question a plan termination when a plan has been in place for at least 10 years. However, a company that terminates a plan that was started at least 5 years prior to termination will not typically receive any inquiry from the IRS.

Can a defined benefit plan be rolled over into an IRA?

Yes, it is possible to roll over a defined benefit plan (DBP) into a 401(k) plan. However, the specific rules and regulations regarding this process may vary depending on the type of defined benefit plan and the 401(k) plan involved. It’s important to carefully review the rules and regulations of both plans before proceeding with the rollover to ensure compliance and avoid any potential penalties or tax consequences.

So let’s assume that you can terminate your plan. Can the defined benefit plan be rolled over into an IRA? The law is relatively straightforward regarding this issue. You can take money out of the defined benefit plan as a complete lump sum distribution.

Alternatively, you are allowed to take the lump sum balance and roll it over into an IRA. Please note that partial distributions or partial rollovers are not allowed.

Can a Defined Benefit Plan be Rolled Over Into an 401k
Can a Defined Benefit Plan be Rolled Over Into an 401k

Because any funds in a defined benefit plan are pre-tax, you can elect to deposit or transfer the funds to a traditional IRA. If you then choose, you can convert the funds to a Roth IRA and pay the taxes immediately. 

A traditional IRA functions like the defined benefit plan in that all taxes are deferred until money is disbursed in retirement. A Roth IRA represents after-tax money. Once tax is paid on conversion, the funds are deposited in the Roth IRA account and is subject to the holding period rule.

Before you decide to terminate your plan and roll it over into an IRA, make sure you discuss the issue with your third party administrator.

So, can a defined benefit plan be rolled over into an IRA? The answer is an absolute yes. But before any termination, make sure that you thoroughly discuss the process with your accountant and administrator. Only then can you ensure that you can keep your distance from the IRS.

It’s also recommended to consult with a financial advisor or tax professional to understand better the implications of rolling over a defined benefit plan into a 401(k) plan and to help determine if it is the best course of action for your unique situation.

Rolling over a defined benefit plan into another retirement account is possible, but it is subject to certain restrictions and limitations. A defined benefit plan is a sort of employer-sponsored retirement plan that provides a guaranteed benefit at retirement based on factors such as salary and years of service. On the other hand, a retirement account is a tax-advantaged savings vehicle that allows individuals to save for their retirement.

Can a defined benefit plan be rolled over into a 401(k)?

While most people will choose to roll over a defined benefit plan into an IRA, you have other rollover options.

You can roll a plan into any other qualified plan, such as a 401(k) or even a SEP. A SEP is technically a type of IRA.

But many people will still keep a 401(k) open even after they’re finished making significant contributions to a defined benefit plan. As such, it can make sense to roll the plan over into the 401(k).

Rollover from (to)Acceptable Account
Defined Benefit PlanIRA, 401(k)
Cash Balance PlanIRA, 401(k)
Target Benefit PlanRoth (taxable event)
401k PlanIRA

But if you are retiring and have no further contributions, it makes the most sense to roll the plan into an IRA. The main reason is the compliance headaches of a 401(k). A 401(k) is subject to mandatory restatements every six years. In addition, a form 5500 must be filed each year that the plan is open and has $250,000+ in assets.

So you have plenty of options. If you’re still working and contributing to a 401(k), the 401(k) rollover might make the most sense.

But if you’re not working anymore and want to consolidate retirement accounts, rolling all your plans over into one IRA account might make the most sense. This way, you have one account that can help monitor all investments. It can make it a little bit easier come tax time as well.

What is a 401k plan?

A 401(k) plan is a particular type of retirement plan offered by employers in the United States. It is actually named after a section of the U.S. tax code that governs it.

Employees may contribute a specified portion of their pre-tax income to the 401(k) plan. The contributions are invested in various investment options chosen by the employee from the plan’s available options. These investments can include stocks, bonds, mutual funds, and other financial products.

Contributions to a 401(k) plan are tax-deferred, meaning they are deducted from the employee’s taxable income in the year they are made. This allows employees to reduce their current tax burden and grow their retirement savings faster.

In some cases, employers will match a portion of their employee’s contributions to the 401(k) plan, which can further increase an employee’s retirement savings.

Withdrawals from a 401(k) plan are subject to income tax and, if withdrawn before age 59½, may also be subject to a 10% early withdrawal penalty. 401(k) plans are regulated by the U.S. Department of Labor and the Internal Revenue Service (IRS).

Can you roll over a defined benefit plan into a Roth IRA?

Defined benefit plan rollovers to Roth IRAs are unavailable unless you’re willing to pay the taxes. First, he would roll the funds over into a traditional IRA. Second, you would convert the traditional IRA to a Roth IRA.

You pay taxes immediately, and the funds in the Roth IRA will be tax-free when you take them out at retirement.

What is the cash balance plan rollover process?

How do you roll over a defined benefit plan into a 401k or IRA?

  1. Determine the rollover amount and why rollover is necessary

    Is it because the participant is leaving and has a vested account balance? Or possibly the plan itself is terminating. The first step is to determine the exact balance that must be rolled over and why the rollover is being requested.

  2. Identify the investment custodian who will receive the funds

    Because the amount will be rolled into a 401k or IRA, ensure you open up an account at a provider like Schwab, Vanguard, or Fidelity who can accept the transfer.

  3. Have the custodian verify the transfer

    The plan TPA and investment custodian can verify the final vested account balance. You must issue a Form 1099-R at the end of the year and file it with the IRS.

  4. Verify receipt of funds

    Receipt of funds can often take a week or so, depending on processing time and the custodian. Ensure that the amount is the same as the vested account balance, net of any disbursement fees.

  5. Process rollover paperwork

    The business will need to get signed distribution forms to instruct the investment custodian to release the funds. Usually, the administrator or TPA will help facilitate the distribution and maintain the compliance paperwork.

Rollover and Distribution Considerations

To determine whether you can roll over your defined benefit plan into another retirement account, you should consider the following factors:

  1. Plan rules: The first step is to review your defined benefit plan rules to determine whether rollovers are allowed. Some defined benefit plans do not allow rollovers, while others may enable rollovers under certain circumstances.
  2. Plan type: The defined benefit plan you have will also affect your ability to roll over the plan. For example, government-sponsored plans may have different rules than private-sector plans.
  3. Age restrictions: Some defined benefit plans may have age restrictions that limit the ability to roll over the plan. You may need to be a certain age or have a certain number of years of service before rolling over the plan.
  4. Tax implications: Rollovers from defined benefit plans to another retirement account may have tax implications. For example, you may need to pay taxes on the amount rolled over and be subject to penalties if you do not follow the correct procedures.
  5. Cost of rollover: The cost of rolling over a defined benefit plan into another retirement account may be significant, especially if you have a large benefit. You may need to pay fees for the rollover process and the administration of the new retirement account.
  6. Investment options: Before rolling over your defined benefit plan, you should consider the investment options available in the new retirement account. Ensure the new account provides a range of investment options that align with your investment goals and risk tolerance.

In conclusion, while rolling over a defined benefit plan into another retirement account is possible, it is essential to consider the above factors before making a decision. It would help if you considered the plan’s rules, the age restrictions, the tax implications, the cost of the rollover, and the investment options available in the new account. If you are still deciding the best course of action, consulting with a financial advisor who can help you navigate the process may be helpful.

Final thoughts

A defined benefit plan is a desirable option for high-income business owners because it allows them to save for retirement in a tax-advantaged manner while providing a guaranteed income stream in retirement.

Defined benefit plans have high contribution limits, enabling business owners to set aside a significant portion of their income for retirement. Additionally, contributions to the plan are tax-deductible, reducing the business owner’s taxable income and potentially lowering their overall tax bill. This can make a rollover easy when understanding can a defined benefit plan be rolled over into an IRA.

Paul Sundin

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