What Should I Do With My 401(k) When I Retire?

Managing your 401(k) assets is a central decision during retirement. The choices you make regarding these savings can profoundly impact your financial security and tax obligations. Understanding your options helps align your funds with long-term financial goals.

Exploring Your 401(k) Distribution Options

Upon retiring, individuals face several choices for their 401(k) plan, each carrying distinct tax implications and investment flexibility. One option is to leave the funds within your former employer’s 401(k) plan, which may be permissible depending on the plan’s rules. This choice can offer simplicity, particularly if you are satisfied with the plan’s investment options and fee structure. However, employer-sponsored plans often have a more limited selection of investment vehicles compared to individual retirement accounts, and their administrative fees might be higher.

Another strategy is to roll over your 401(k) into a Traditional Individual Retirement Account (IRA). This maintains the tax-deferred status of your savings, with taxes due only upon distribution. A key advantage is the expanded investment choices, allowing for greater diversification and control. Consolidating multiple old 401(k) accounts into a single Traditional IRA also simplifies financial management.

Alternatively, consider rolling over your 401(k) into a Roth IRA. This involves paying income taxes on the converted amount in the year of conversion, as funds move from a pre-tax to an after-tax account. While this creates an immediate tax liability, qualified withdrawals in retirement are entirely tax-free, including earnings. Roth IRAs also do not have Required Minimum Distributions (RMDs) for the original owner, providing flexibility to leave funds untouched longer. However, converted funds must be held for at least five years before qualified tax-free withdrawals can be made, or penalties may apply.

Cashing out your 401(k) is not recommended due to significant tax consequences. A lump-sum distribution is treated as ordinary income in the year of withdrawal, potentially pushing you into a higher tax bracket. If you are under age 59½, an additional 10% early withdrawal penalty applies to the taxable portion. This approach severely diminishes retirement savings and should be avoided unless under extreme financial duress.

Understanding Required Minimum Distributions

Required Minimum Distributions (RMDs) are amounts that must be withdrawn annually from most tax-deferred retirement accounts once you reach a certain age. RMDs begin at age 73, a change implemented by the SECURE 2.0 Act, which will further increase to age 75 in 2033. For individuals still working, RMDs from a current employer’s 401(k) plan can be delayed until retirement, provided you are not a 5% owner of the business.

RMDs are calculated by dividing the account balance as of December 31 of the previous year by a life expectancy factor from the IRS Uniform Lifetime Table. This determines the minimum amount to withdraw to avoid penalties. The purpose of RMDs is to ensure taxes are eventually paid on tax-deferred retirement savings.

Failing to take a full RMD by the deadline can result in a penalty. The penalty is 25% of the amount not withdrawn, though it can be reduced to 10% if corrected within two years. Understanding and adhering to RMD rules is important for Traditional IRAs, SEP IRAs, SIMPLE IRAs, and most 401(k) and 403(b) plans. Notably, Roth IRAs do not require RMDs for the original owner, and starting in 2024, Roth 401(k)s also became exempt from RMDs for the original owner.

Navigating Withdrawals from Your Retirement Accounts

Accessing your retirement funds involves specific procedures and tax considerations. Distributions can be taken as either periodic payments, such as monthly or quarterly installments, or as a lump-sum withdrawal. The chosen method can influence your cash flow and tax planning throughout retirement.

To initiate withdrawals, work directly with your account custodian or plan administrator, through online portals, forms, or phone contact. This involves setting up a distribution schedule, specifying the amount and frequency of desired withdrawals. Ensuring contact and banking details are current with the custodian facilitates timely and accurate distributions.

Federal income tax withholding applies to retirement distributions, with rates varying by distribution type. For eligible rollover distributions from employer plans, a mandatory 20% federal tax withholding applies if funds are paid directly to you, rather than transferred trustee-to-trustee. For non-periodic payments from IRAs, a default 10% withholding applies, though you can elect a different rate via IRS Form W-4R. Manage withholding carefully to avoid an underpayment penalty, which occurs if you do not pay at least 90% of your current year’s tax liability or 100% of your prior year’s tax through withholding or estimated payments.

State income tax withholding on retirement distributions varies by state, with some mandating withholding and others making it optional. Complete state-specific withholding forms to ensure correct state tax is withheld from your distributions. Understanding these requirements avoids unexpected tax burdens at year-end.

Inherited Accounts and Beneficiaries

Inherited accounts typically follow a 10-year distribution rule, meaning the full balance must be distributed within ten years of the original owner’s death. Exceptions exist for eligible designated beneficiaries, such as surviving spouses.