What Should You Do With Your 401(k) When You Retire?

You can leave your assets in your 401(k) account until you reach the required minimum distribution age. Shutterstock

After years of hard work and saving diligently in your 401(k), you’ve finally retired. You’re probably wondering what’s going to happen to your 401(k).

Generally speaking, you have the following options:

Keep your 401(k). If your plan allows it, you can leave your assets in your 401(k) account until you reach the required minimum distribution (RMD) age—currently age 73.

But thanks to the SECURE 2.0 Act (SECURE refers to Setting Every Community Up for Retirement Enhancement), the RMD age will increase to 75 in 2033. This essentially means that your RMD age would be 75 if you were born in or after 1960.

Rollover into an individual retirement account (IRA). You can ask your plan administrator to make a direct transfer or in-kind transfer to an existing or new IRA. This simply means that your 401(k) plan administrator would transfer the assets held in your account into an IRA held at a different financial institution. As a result, you won’t need to sell the assets in your 401(k) account and use the proceeds to purchase new shares in your IRA. That could trigger capital gains taxes. But through an in-kind transfer, you avoid this taxable event. An in-kind transfer is also referred to as a trustee-to-trustee transfer because it involves a transfer between two financial institutions working on behalf of an individual. In other words, you don’t actually get the money in physical form.

Depending on your 401(k) balance and other variables, however, some administrators may automatically roll over your 401(k) into an IRA with a specific provider. Or they’ll cash out the account and send you a lump sum via check. In this case, you have 60 days to roll over the funds into an IRA or it’ll be considered taxable income. And you may face an early withdrawal penalty of 10 percent if you’re under the age of 59 1/2.

Cash out your 401(k). Depending on your plan, you may be able to withdraw all funds from your 401(k) in a lump sum or through installment payments.

Each of these options has its advantages and disadvantages. So let’s take a closer look at each.

Keep Your 401(k)

Under certain circumstances, some plan administrators allow participants to keep their assets within the company 401(k) plan. This could be a benefit for many retirees.

In fact, more than half (54 percent) of retirees chose to leave their savings in their most recent employer’s plan, according to a recent Pew survey. And 55 percent of those retirees said their investment options were the most important reason they'd decided to keep their savings in their 401(k) plans.

This makes sense. Plan sponsors of 401(k)s are required to engage in due diligence when selecting fund options for these plans. In some cases, plan participants have access to exclusive investment options and funds with lower fees than those available to the general public.

But costs can also come in the form of administrative fees, which vary widely across plans. It can be tricky to come up with a number. But you can take a look at the plan’s annual document (Form 5500) to see total administrative expenses. You can then divide that amount by total plan assets to get a percentage. You can think of this as the annual management fee on your 401(k) portfolio. It should be something lower than 0.25 percent.

Moreover, keep in mind that if you leave your assets with your 401(k) plan after you retire, you can no longer contribute to the plan. So you’d need to rely on the potential of your current investments and your specific drawdown strategy.

Still, 401(k) plans offer some distinct benefits. If you retire and your assets are still in the company’s plan, you can withdraw funds penalty-free when you reach age 55 if the plan allows it.

Plus, 401(k)s offer protections that may be crucial for certain investors. Generally speaking, 401(k) plans enjoy a higher degree of protection from creditors than IRAs. However, these laws vary by state. So in this situation, you may want to seek the assistance of a qualified attorney and tax advisor.

Rollover to an IRA

When you roll over your 401(k) assets to an IRA, you can continue contributing to your account as long as you have some form of taxable income. This allows your money to keep growing with a tax advantage.

And most providers permit you to invest your retirement funds in a wider variety of investment options, such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Some may even offer alternative investments such as gold IRAs.

To remain competitive, many IRA providers also offer a variety of digital tools like investment screeners, exclusive research platforms, real-time market analysis, and more to help you manage your retirement portfolio.

These days, many IRA providers don’t charge transaction fees for trading stocks, ETFs, and options. And some offer proprietary ETFs and index funds with little to no fees.

Still, you should always analyze and compare fees from different IRA providers. Some charge additional fees or require large minimum investments for personalized advice. But depending on your financial situation, this may be a plus and a major reason to move money from your 401(k) and into an IRA.

But what if you want a Roth IRA? You can roll over traditional 401(k) assets into a Roth IRA. But you’d need to pay taxes on the conversion. The upside is that Roth IRA withdrawals are tax-free if you’re at least 59½ years old and your account has been opened for at least five years. But the rules can get complicated here. So you can benefit from consulting a qualified tax advisor.

Take a Lump Sum

When you retire, you can always just cash out your traditional 401(k) funds. But this may not be the best option for all. The withdrawal would be treated as ordinary income for federal tax purposes. State taxes may apply, too. And if the withdrawal is large enough, it may push you to a higher tax bracket. This could affect how your Social Security benefits are taxed and how much you pay for certain Medicare premiums.

If you’re younger than 59 1/2, you’d likely face an early withdrawal penalty.

However, your 401(k) administrator may allow for the rule of 55. If you turn 55 or older in the calendar year that you lose or leave your job, you may be allowed to start making withdrawals from your 401(k) without facing the early withdrawal penalty. Still, you’d owe regular income tax on the traditional 401(k) distributions because this is a type of tax-deferred account.

But if you intend to drain your 401(k) outright when you retire, you should have a plan to make the most of that money while mitigating the tax impact. For instance, you may ask your plan provider to directly transfer your assets into a Roth IRA. You’ll owe taxes on the amount you’re converting, which can be a hefty amount, especially if you’ve accumulated substantial savings. However, you’ll be able to withdraw funds from a Roth IRA tax-and-penalty-free as long as you’re at least 59 1/2 years old and the account has been open for at least five years.

And as long as you have earned income such as wages and tips and you meet certain income limits, you can continue contributing to your Roth IRA at any age. If your income exceeds these limits, you could engage in a backdoor Roth IRA strategy. You can also consider building a Roth conversion ladder. If done right, this could allow you to withdraw funds from your Roth IRA tax-and-penalty-free before reaching age 59 1/2.

No matter what your situation, however, it can always help to consult a qualified tax adviser.

The Bottom Line

Like everything with retirement planning, the right answer depends on your individual circumstances. If your company lets you keep your hefty 401(k) with stellar investment options and minuscule fees, then keeping your savings in-plan may be a solid option. But for those with less than favorable 401(k)s, an IRA rollover may seem more lucrative. Still, some people may benefit from taking their savings all in a lump sum or installment payments.

Whatever the case, you should carefully weigh the pros and cons of all your options. Here is a quick checklist of points to consider before making a decision:

• Fees
• Fund options
• Liquidity needs
• Tax implications
• Legal protections

For more retirement saving tips, check our five steps to wrap up your finances strong this year.

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