You’ve worked your entire life and have finally reached that point when you are ready to retire. But what happens to all the money you’ve been putting away and how does a 401(k) work after retirement?
There are a lot of people who don’t know what to do with their 401(k) after retirement and have little knowledge of how to handle the process. Managing your retirement savings account properly in retirement is just as important as it was when you were contributing to its growth during your employment years.
Rules about what you can do with your 401(k) account are also based on IRS regulations and your employer's plan. It’s important to consult with your company’s plan administrator for details on what is allowed or required before you make any changes. Luckily, you have plenty of options from which to choose, and if you are under the age of 59 and a half, it is important to decide which option suits your personal and financial situation best.
Leave the 401(k) with your employer
This is probably the easiest option to consider when you retire. If you are happy with the plan and investment options you already have set in place, you could leave the account as is and let it continue to grow with your employer. The account stays tax-deferred and accumulates without getting taxed. It’s also easy to change your asset allocation in your 401(k) plan without paying a transaction fee when transferring money between investments.
Another benefit to keeping it with your employer is that you can borrow from your 401(k), which can be useful if you are under the age of 59 and a half and need to take some money out before your full retirement age. Although some employers have different rules and restrictions on taking money out early, you should still check to see if this is a viable option for you. A word of caution: if you can’t pay back the money you took out, you will be required to pay a 10% early withdrawal penalty fee.
When you retire you can take a lump-sum distribution, which is basically cashing out your 401(k). But there are some cons to this option. If you cash out your 401(k) early at the age of 59 1/2 then you will have to pay a 10 % penalty fee. If you have a large amount in your 401(k) account you can end up paying more tax on one big withdrawal.
Cashing out your 401(k) is typically not recommended unless you need the funds for an emergency because you’ll end up paying more tax and lose future earnings for your retirement savings plan.
Roll the money over into an IRA
If you don’t like your employer's 401(k) plan and want to cash out that lump sum but don’t want tax liabilities and penalties then you should consider rolling it into an IRA. You'll have more control of your investment portfolio and have more investment options from the brokerage as well as lower fees.
What’s also great about IRAs is that you can consolidate all of your 401(k) accounts into just one IRA account. This way you can easily manage your investments in one place and the investment firm can assist you with asset allocation for your retirement plan. If you are still unsure about rolling over into an IRA then you can rely on the services of a financial adviser, but you should know that you don’t have to take their advice and they might not be the right fit for you. Most investment firms provide this service to clients as well as assist them with any questions they may have about retirement savings and investments.
Of course, there are fees with this option. A trading cost or commission fee will take place when you trade your investments, which can make rebalancing your accounts more difficult than it would in a 401(k). Ultimately, you will have all the control over your retirement portfolio but with that comes more responsibility in managing your own investments.
If you want to avoid investing in an IRA or switching accounts then another choice would be taking periodic distributions from your 401(k) plan. This is a great option if you are happy with your savings plan and feel that it could support your financial needs to last throughout your life expectancy. Some plans let you choose a desired amount to receive periodically, usually monthly or quarterly, and you can also change the amount once a year.
Learning how to manage your 401(k) plan when you retire is an essential part of your retirement life and financial plan. It’s also important to know key strategies in saving for your retirement early on so it works for you instead of against you.