What to Do With Your 401(k) When You Retire

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Updated on Friday, February 8, 2019

With so much retirement advice focused on how to save as much as possible, the question of how to access the money in your 401(k) account can often get overlooked. But understanding how to turn your employer-sponsored retirement account into retirement income is an essential part of post-retirement financial security.

This is why every worker approaching retirement should review the payout policy of his or her specific 401(k) account well before leaving work for good. This policy outlines the rules governing your withdrawals from your 401(k).

While some 401(k) accounts allow for installment plans that pay you on a monthly or quarterly basis, others require lump-sum distributions or have other regulations regarding the size and timing of distributions. Knowing exactly what to expect from your employer’s 401(k) payout policy can help you plan your retirement income strategy.

While understanding the payout policy of your 401(k) is one portion of creating your retirement income strategy, there are several other issues you need to consider when deciding what to do with your 401(k) in retirement.

4 important rules to know

There are several IRS rules governing 401(k) distributions that you need to be fully aware of so you can stay on Uncle Sam’s good side.

1. Qualified distributions

Age 59 and a half is when 401(k) account holders are eligible to take qualified distributions, which means you can access money from your 401(k) account without having to pay the 10% early withdrawal penalty. You will still pay ordinary income tax on these distributions.

2. Post-retirement contributions to your 401(k)

When you retire from the employer who holds your 401(k) account, you are no longer eligible to make contributions to that account. If you want to keep making contributions after retirement, you may roll over your 401(k) into an IRA or simply open a new IRA to contribute to while leaving your funds to grow in your 401(k).

However, you can only do this if you are still earning income. Since your IRA contributions must come from earned income, full retirement means no more contributions to retirement accounts. In addition, you must be under the age of 70 and a half to make contributions to a traditional IRA.

3. Penalty-free early retirement

If you retire or lose your job at age 55 or later, you can still access your 401(k) funds without paying the 10% penalty. This can help any worker who is either involuntarily retired, laid off or who decides to retire earlier than they planned.

4. Required minimum distributions (RMDs)

As of age 70 and a half, 401(k) account holders are required to take minimum distributions each year. The amount of the distribution is based upon your age and your 401(k) balance. One major benefit of 401(k) plans is that most plan administrators do this calculation for you.

What to do with your 401k in retirement

Of course, just knowing the rules and requirements doesn’t necessarily make it clear what you can and should do with your 401(k) once you’ve reached retirement. That’s why it’s a good idea to familiarize yourself with the most common options for accessing your 401(k) funds in retirement:

  • Leave it in place: Many 401(k) participants choose to simply leave their funds in the plan as they take distributions from it throughout their retirement. That’s because your employer is required to keep any 401(k) amounts greater than $5,000 invested according to your previously set asset allocation. You can take distributions while the remainder continues to grow.
    The only caveat to this option is what happens if you have less than $5,000 invested. If your account has less than that as of your retirement, it could trigger a lump-sum distribution, which will include taxes of the lump-sum at your marginal tax rate.
  • Rollover to an IRA: Leaving your 401(k) funds in place may not be the best option if your plan administrator charges higher fees than you want to pay or if the asset allocation options are more limited than you’d like. If you would like more control of either, you can choose to roll over your funds into an IRA. A rollover will also allow you to keep investing for retirement if you continue to have earned income even after separating from your employer.
  • Fund an immediate annuity: In some cases, 401(k) account holders can use their entire account balance to fund an immediate lifetime annuity. Such an annuity will provide the beneficiary with a monthly payout for life. In addition, this kind of transfer to an annuity will help alleviate the taxes that would be assessed with a lump-sum withdrawal, allowing you pay taxes on your annuitized income as you go rather than all at once.

Mind the (budget) gap

No matter how you plan to access your 401(k) funds in retirement, it’s important to plan ahead for your retirement expenses. There are several questions you need to ask yourself before you make the leap to retirement:

  • Do you have a current budget?
  • Have you planned your retirement budget?
  • Will you have enough money to last your entire retirement at your current annual level of spending?
  • Are there expenses you can cut to make sure your money will last?
  • When do you plan to take Social Security benefits? How much will you get per month from Social Security?
  • How can you bring in more income after you retire? Are you willing to work longer, take part-time employment early in retirement or downsize to reduce expenses?

Making sure you answer these questions before you retire can mean the difference between a comfortable second act and finding yourself retired without enough money.

Bottom line

Figuring out exactly how to access the money in your 401(k) means understanding the legal requirements set by the IRS, the specific policies of your 401(k), and your retirement income needs. Knowing what to expect from each of these can help you find the right 401(k) distribution strategy for your retirement.