The primary reason retirement investors seek to establish a Self-Directed IRA is for the investment opportunities and diversification potential.  For defined benefit or cash balance plan investors, gaining the ability to diversify the significant wealth they have accumulated in the pension plan is extremely attractive. Therefore, there are numerous benefits of rolling over a defined benefit plan.

What is a Self-Directed IRA?

A Self-Directed IRA is a type of IRA that allow ones to invest in non-traditional assets, such as real estate. Self-Directed IRAs can generally invest in any assets except:

• Collectibles
• Life insurance
• Any investment that directly or indirectly involved or benefits a ”disqualified person” (i.e. the IRA holder, any of his or lineal descendants, or any entity controlled by such persons).

The primary tax advantage of using a Self-Directed IRA is that all income and gains go back to the IRA without tax, or tax-free in the case of a Roth.

Read More: Self-Directed IRA Prohibited Transaction Rules

Self-Directed IRA Rollover

One of the more popular ways to fund a Self-Directed IRA is via a contribution, transfer or rollover. In general, you can transfer tax free assets (money or property) from any retirement plan to a Self-Directed IRA without tax or penalty.  This includes IRAs, defined contribution plans, such as 401(k)s, and even defined benefit or cash balance plans. Rollovers are the most popular way of funding an IRA.  In 2018, there was approximately $480 billion rolled into IRA accounts.

Under the IRS rollover rules, one can rollover any pre-tax defined contribution or defined benefit plan assets tax-free to a pre-tax, or traditional, IRA.  The same rules apply to the Roth portion of a defined contribution plan which can be rolled into a Roth IRA tax- and penalty-free. 

Defined Contribution Plans

The most common type of defined contribution plan is a 401(k) plan.  A 403(b) and 457(b) employer plans are also types of defined contribution plans.  In a defined contribution plan, retirement benefits are not guaranteed. They are funded primarily by the employee, as the participant defers a portion of their gross salary. Employers can match the contributions up to a certain amount, in certain circumstances.

In general, a plan participant is not permitted to rollover funds to an IRA or another 401(k) plan unless there is a plan triggering event. The plan triggering rules essentially restrict a plan participant from rolling over 401(k) plan funds to another retirement plan or take a distribution, except for certain hardship exceptions, until they reach the age of 59 1/2, they leave their job, or the plan is terminated. Hence, unless a plan participant is able to satisfy one of the plan triggering rules or specific exception, such as a hardship, he or she will likely not be able to do a rollover of defined contribution plans to a Self-Directed IRA.

Defined Benefit/Cash Balance Plan

In a defined benefit or cash balance plan, the employer funds and guarantees a specific retirement benefit amount for each participant.  The cash balance plan is the most popular type of defined benefit plan. The primary advantage of a defined benefit plan is that it will allow a business owner to supercharge their annual tax-deductible contributions as well as potentially generate millions in tax-deferred wealth.

The establishment of a defined benefit or cash balance plan is required to be permanent.  The IRS has not issued any formal rulings as to the number of years a defined benefit plan must be kept open to satisfy the permanent requirement, however, most tax professionals suggest that a defined benefit or cash balance plan be opened at least three to five years to be safe. In other words, any employer that has established a defined benefit or cash balance plan should not attempt to rollover any defined benefit plan assets to an IRA prior to at least three years, but probably not before five years just to be safe.  In addition, it is crucial that the business owner work closely with the individual or firm that was responsible for the defined benefit plan design and administration before making any IRA rollover decisions.

Investment Decisions

In addition to the three or five-year rule for defined benefit plans, the majority of defined benefit or cash balance plans are invested in conservative types of investments in order to provide more predictability to the business owner.  In order to determine the maximum amount of benefits that can be generated in a defined benefit plan, an actuary will calculate the annual plan contribution range based on IRS guideline. Most actuaries use a 4% interest rate to get to an interest credit for cash balance/defined benefit credit calculation purposes.  Actuaries typically use a conservative annual interest rate to offer business owners more flexibility in order to best protect against lower plan returns as a result of a down market. 

Hence, when it comes to making investments in a defined benefit plan, most financial advisors will suggest a conservative investment approach.  The idea is to keep the plan investments in annual return range of 4%-6% so that the business owner will not have to make up any plan funding shortfalls.

Rolling Over a Defined Benefit Plan

It is for this reason that once the defined benefit plan has generated all its permitted benefits under the plan documents and the plan has been opened at least three to five years, it is common for many defined benefit plan funds to be rolled into a self-directed IRA.  The rollover is tax-free, and the process is quite easy. 

• Simply establish a Self-Directed IRA at a Self-Directed IRA custodian, such as IRA Financial Trust. 
• Once the account has been established, confirm with your pension plan administrator that the plan funds are eligible for rollover. 
• Confirm the defined benefit funds you wish to transfer to the new IRA are in cash and then complete the tax-free rollover to the new Self-Directed IRA. 
• It will then be funded so you have the power to make IRS-approved alternative asset investments with the funds
• All Self-Directed IRA investment income and gains will flow back to the IRA without tax.

Conclusion

The defined benefit/cash balance plan is probably the best and most underrated retirement plan for a small business owner. The ability to generate huge annual tax deductions as well as accumulate significant tax-deferred retirement wealth makes it such an attractive retirement plan.  Since most defined benefit plans contain meaningful retirement assets, rolling the funds to a self-directed IRA to invest in alternative assets, such as real estate is a very popular option.  The key is to confirm with the defined benefit plan administrator that the pension plan has been in existence long enough to have been fully funded and satisfy the permanency requirement.  A rollover of defined benefit plan funds to a self-directed IRA is tax-free and penalty-free and will give the business owner more control over their retirement assets as well as the ability to invest in a more diverse group of assets.

To learn more about self-directed retirement options for your defined benefit plan or cash balance plan, please contact a self-directed retirement expert at 800-472-0646.