Center for a Secure Retirement
How Does a 401(k) Work When You Retire?

How Does a 401(k) Work When You Retire?

A 401(k) plan can be a great way to save for retirement, but many people lack guidance on what to do with this financial tool after they retire. There are several ways to take advantage of a 401(k) based on your needs and goals, and understanding each option can help you feel more comfortable with making your own decision.

How Does a 401(k) Work When You Retire?

In general, there are four courses of action you could take with your 401(k):

  1. Keeping it where it is.
  2. Converting it to an individual retirement account (IRA).
  3. Cashing it out completely.
  4. Transferring it to a new employer.

Factors you should keep in mind as you decide between these options include the costs of early withdrawal fees, when you can start withdrawing without incurring fees, and how you can continue to contribute to your accounts during retirement.

Options for Leveraging Your 401(k) in Retirement

While there are many ways to withdraw funds from a 401(k) plan, most people will want to avoid taxes and early withdrawal fees if possible. You can make penalty-free withdrawals beginning at age 59 and a half to avoid the IRS's 10% early withdrawal penalty, or at age 55 if you have been laid off or chosen to retire early. In addition to any penalty-free withdrawals you make, you will have to start taking the required minimum distribution (RMD) — the amount you are required to withdraw from retirement savings accounts to avoid tax consequences — by age 72.

To contribute to any sort of retirement or employer-sponsored plan, you need earned income from a job or self-employment. Once you retire, you cannot make any additional contributions to a current 401(k) plan. To continue investing, you will need to consider a 401(k)-to-IRA rollover.

Let's explore this and the other options for managing your 401(k) in greater depth.

1. Keeping It Where It Is

Keeping your 401(k) plan where it currently resides is the easiest option because there are no additional steps to take, but you might not be able to receive some of the benefits of other options described below.

Technically, the investing options should remain the same as long as your employer does not change investment companies. If you keep your 401(k) plan where it is, it should continue accumulating until at least age 72, when you would need to take the RMD.

2. Converting It to an IRA

Converting your 401(k) to an IRA is another option to consider. In this case, you would avoid paying taxes because the conversion is a "like-to-like" transaction from one pretax account to another. This rollover would allow you to continue contributing to your retirement account without having it dispersed between different account types.

You might have heard that there are more investment choices and lower fees with an IRA, but that's not always the case. Be sure to review the proposed investments and make the appropriate selections based on your risk tolerance and financial plans. Speaking with a financial professional can help to simplify this process.

3. Cashing It Out Completely

Cashing out your 401(k) completely might be a good option if you need quick access to cash. It's not a tax-efficient way of withdrawing your funds, however, as at least 20% will automatically be withheld by the IRS, and you will be in a higher tax bracket for that year. These withholdings do not include any additional taxes on your Social Security payments or Part B Medicare premium increases. If you're looking to cash out your 401(k), it's typically best to request it as a lump sum.

4. Transferring It to a New Employer

Transferring your 401(k) to a new employer is another option if you continue working after retirement. While the idea of consolidating your accounts in one place might seem appealing, be aware that investment options might say otherwise. Not all 401(k)s are created equal, and some have limited investment choices, so it's best to review any documentation and perhaps consult with a financial advisor to ensure that you're making the right choices.

Choose the Path That Best Fits Your Needs and Goals

So, how does a 401(k) work when you retire? It's up to you to determine. Making this determination can seem daunting, but once you understand the rules and benefits of the options available, you will be well-equipped to decide which course of action will best suit your retirement needs. Whether you need a quick infusion of capital from cashing out your 401(k) or you want to continue investing through a 401(k)-to-IRA rollover, talking with a financial professional to ensure that you fully understand the advantages and tax implications of your options is a smart choice.

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