What Should I Do With My 401k Right Now?

A 401(k) plan is a foundational component of retirement savings. It is an employer-sponsored account allowing employees to contribute a portion of their salary, often with an employer match, into investments. Funds grow with tax advantages, meaning taxes are typically deferred until retirement or, for a Roth 401(k), paid upfront for tax-free withdrawals later. Understanding how to manage and access these funds throughout different life stages is important, including navigating contributions while employed, making informed decisions when changing jobs, and planning for distributions in retirement.

Navigating Your Active 401k

For individuals currently contributing to a 401(k) through their employer, several actions can optimize the account. Adjusting contribution percentages is a direct way to impact savings, allowing you to increase the amount deducted from each paycheck. For 2025, employees can contribute up to $23,500; those aged 50 and older can contribute an additional $7,500 in catch-up contributions, bringing their limit to $31,000. These limits apply across all 401(k) accounts if you have multiple plans.

Reviewing and changing investment allocations is important. Assess fund types like target-date, stock, or bond funds to align with your risk tolerance and goals. Rebalancing periodically helps maintain your desired asset allocation. Your plan administrator can provide details on available options and how to make changes.

Some 401(k) plans offer the option to take a loan from your vested balance. The IRS limits a 401(k) loan to the lesser of 50% of your vested account balance or $50,000. These loans are repaid with interest, which goes back into your own account, usually through payroll deductions over five years, though a longer term may be allowed for a primary residence purchase. Unlike withdrawals, 401(k) loans are not taxable income as long as they are repaid according to the terms.

In situations of immediate financial need, a 401(k) hardship withdrawal might be an option. The IRS defines specific qualifying circumstances, such as certain medical expenses, costs related to buying a principal residence, or payments to avoid eviction or foreclosure. While a hardship withdrawal allows access to funds, it is subject to income taxes and, if you are under age 59½, a 10% early withdrawal penalty, unless a specific exception applies. The amount withdrawn is limited to the immediate financial need and cannot be repaid to the account, unlike a loan.

Decisions for a Previous Employer’s 401k

When leaving an employer, you have several options for your previous 401(k). Each choice has distinct implications for accessibility, investment management, and taxation, requiring an informed decision about your retirement savings.

One option is to leave the funds in your former employer’s 401(k) plan. This may be permissible if your account balance exceeds a certain threshold, often $5,000, as plans may automatically cash out smaller balances. This allows funds to continue growing tax-deferred within the existing plan, but you cannot contribute to it. Consider if the former plan’s investment options and fees are competitive compared to alternatives.

Alternatively, you can roll over funds into your new employer’s 401(k) plan, if it accepts rollovers. This consolidates your retirement savings into a single account, simplifying management and potentially allowing for continued contributions and employer matching. The process involves a direct rollover, where funds are transferred directly from the old plan administrator to the new one, avoiding immediate tax implications or withholding.

A common choice is to roll over the 401(k) into an Individual Retirement Account (IRA). This offers greater control over investment choices, as IRAs have a wider array of options than employer-sponsored plans. You can choose between a Traditional IRA rollover or a Roth IRA rollover.

A Traditional IRA rollover maintains the tax-deferred status of your pre-tax 401(k) contributions, meaning taxes are due upon withdrawal in retirement. For a Roth IRA rollover, if the original 401(k) was a Traditional 401(k), the conversion amount is taxed as ordinary income in the year of the rollover, but qualified withdrawals in retirement will be tax-free. If the original 401(k) was a Roth 401(k), the rollover to a Roth IRA is tax-free.

When performing a rollover, a direct rollover is recommended. Funds move directly from your old plan administrator to the new account, preventing mandatory tax withholding. An indirect rollover, where a check is issued to you, is also an option, but the former plan administrator must withhold 20% for federal income taxes. If you choose an indirect rollover, you must deposit the full amount, including the 20% withheld, into the new retirement account within 60 days to avoid it being treated as a taxable distribution and potentially subject to an early withdrawal penalty if under age 59½. Failing to deposit the full amount means the withheld portion is considered a distribution, subject to taxes and penalties.

The final option is to cash out the 401(k) by taking a direct distribution. This has significant tax consequences. The entire distribution is taxed as ordinary income in the year received. If you are under age 59½, a 10% early withdrawal penalty applies to the taxable portion.

Limited exceptions to this penalty exist, such as separation from service at age 55 or older, total and permanent disability, or certain unreimbursed medical expenses. Even with an exception, the distribution remains taxable income.

Accessing Your 401k in Retirement

As you approach or enter retirement, understanding how to access your 401(k) funds becomes a primary focus. There are several ways to take distributions, each with different implications for your income and tax planning. Tax treatment depends largely on whether your 401(k) was a traditional (pre-tax) or Roth (after-tax) account.

One common method is a lump-sum withdrawal, where you take the entire vested balance at once. While this provides immediate access, the entire amount from a traditional 401(k) is taxed as ordinary income in the year of withdrawal, potentially pushing you into a higher tax bracket.

Alternatively, you can opt for systematic withdrawals, which involve receiving periodic payments from your account over a specified period or in a set amount, such as monthly or quarterly payments. This approach provides a steady income stream, similar to a paycheck, and allows remaining funds to continue growing. Payments from a traditional 401(k) are taxed as ordinary income as you receive them.

Some 401(k) plans may offer annuity options, which convert a portion or all of your account balance into a guaranteed stream of income for a set period or for life. An annuity is a contract with an insurance company, and payments received are taxed as ordinary income from a traditional 401(k). This option provides income certainty but offers less liquidity than other withdrawal methods.

Regardless of the distribution method chosen, Required Minimum Distributions (RMDs) become a factor for traditional 401(k) accounts. RMDs are the minimum amounts you must withdraw from your retirement accounts annually once you reach a certain age. For those turning 73 in 2023 or later, the RMD age is 73. Your first RMD must be taken by April 1 of the year following the year you reach the RMD age, with subsequent RMDs by December 31 each year. Failing to take your RMD can result in a 25% penalty of the amount that should have been withdrawn, though this penalty may be reduced to 10% if corrected promptly.

The tax implications differ between traditional and Roth 401(k)s during retirement. Distributions from a traditional 401(k) are taxed as ordinary income because contributions were made with pre-tax dollars and grew tax-deferred. In contrast, qualified distributions from a Roth 401(k) are entirely tax-free, provided the account has been held for at least five years and you are at least 59½ years old. Due to recent legislation, Roth 401(k) accounts are not subject to RMDs during the account owner’s lifetime, aligning them with Roth IRAs.