What do I do with my 401k when I retire?

Over your working years, you’ve diligently contributed to your 401(k) retirement account. Now that you are retired, what do you do with the money? A recent study by Cerulli Associates revealed that most people approaching retirement are not sure what to do with their retirement money.

Once you have retired, you can opt to leave the 401(k) behind, rollover the 401(k) to an IRA, or start taking distributions. You must be age 59 ½ or older to start taking distributions without penalty from IRS, or 72 to start taking required minimum distributions. If you are 55 when you retire, you can withdraw money from your current 401(k) without paying an early withdrawal penalty. However, this rule of 55 does not apply to your previous 401(k)s.

Leave 401(k) with Former Employer      

You can choose to leave the money in the 401(k) plan as you figure out what to do. You can also decide to let the money sit in the plan if you are happy with the investment options provided by your former employer. Your retirement savings will continue growing tax-deferred until you take a distribution, or transfer the money to another retirement account.

If you want the former employer to continue managing your retirement money, your 401(k) balance must have at least $5000. If your balance is below $5,000, the former employer will force a rollover to an IRA of their choice, or trigger a lump-sum distribution. If the former employer forces a cash out, it will automatically withhold 20% of the distribution for paying taxes.

Continue saving for retirement

After you have retired, you can choose to continue contributing to a retirement plan. Since you cannot contribute to the 401(k) left with the former employer, you can rollover the money to an IRA. However, the IRS requires that you can only contribute earnings such as wages, salaries, tips, and bonuses, but not social security earnings and investment earnings.

Take a distribution

If you retire after attaining age 59 ½, you can start taking distributions from your 401(k) account without paying a penalty tax. You can choose to take a lump-sum distribution or annuities for a fixed period or over your lifetime. Although you won't pay an early withdrawal tax, the distributions are considered an income, and you will owe income taxes at your tax bracket rate.

If you have a Roth 401(k), you can start taking tax-free and penalty-free distributions when you retire. A Roth 401(k) account is funded with after-tax money, and this means you won't pay any taxes when you take a distribution. However, you must be age 59 ½ or older and have held the Roth account for five years or more.

Factor In “Age 55 Rule”

If you retire at 55 but not yet 59 ½, you can start taking penalty-free distributions. The Age 55 Rule only applies to the current employer who you just left, and not older 401(k)s left with former employers. If you decide to rollover your 401(k) to IRA, this rule does not apply. You will still owe income taxes and a 10% penalty when you withdraw money from the IRA before you reach 59 ½. 

Rollover 401(k) to IRA

Once you retire from your job, you can decide to rollover the 401(k) to an IRA. Start by opening an IRA account, and provide instructions to your former employer to transfer your retirement savings to the IRA account. If you have older 401(k)s, you can consolidate them into the IRA for easier management.

There are certain benefits of rolling over 401(k) money to an IRA. First, you will have a wider pool of investment options you can pick. You can invest in stocks, bonds, ETFs, certificates of deposit, tax deeds, REITs, etc. You can also choose investments with the lowest fees to reduce costs.

In addition, an IRA provides more withdrawal options than a 401(k). You will have greater flexibility with your retirement money, and you can choose to set up automatic monthly withdrawals to meet your daily expenses. An IRA also gives you access to retirement advisors, and you can get professional advice on how to manage your retirement savings better.

Required Minimum Distributions (RMDs)

Once you have retired, you are not required to start taking the mandatory distributions until you are 72. If you just turned 72, you must start taking RMDs from your 401(k) starting from April 1 of the year after you turn 72. After the first distribution, you must take RMDs each year based on your life expectancy and account balance. You cannot withdraw less than your RMD in any given year, but you can decide to take more than you are required to withdraw.

If you are still working in the company after age 72 and you don’t own more than 5% of the company, you could be allowed to delay taking RMDs until when you retire from the company. If you are a qualified participant, you should check with the 401(k) plan to know if you are eligible to deter taking contributions.