What Should You Do With Your 401k When You Retire?

When individuals conclude their working careers or transition from an employer, their 401k plan is a significant financial consideration. This retirement savings vehicle typically holds a substantial portion of a person’s accumulated wealth, earmarked for post-employment years. This article explores the various pathways individuals can take with their 401k balance once employment ends, guiding them through the choices and procedural aspects.

Primary Choices for Your 401k

Upon leaving an employer or retiring, individuals have several choices for their 401k funds. One option involves leaving the money within the former employer’s 401k plan, if the account balance meets minimum thresholds (e.g., $5,000) and plan rules permit. Keeping funds in the previous plan means continued management under its terms and investment options, which may be limited.

Another common pathway is rolling over funds into an Individual Retirement Account (IRA). This transfers savings into an individual-controlled account, often with broader investment choices. The original 401k’s tax classification (traditional or Roth) dictates the type of IRA that can receive funds, ensuring consistent tax treatment.

Individuals transitioning to a new job can roll over their 401k balance into their new employer’s plan. This depends on the new plan’s rules, as not all employer plans accept incoming rollovers. Consolidating funds simplifies management by keeping assets in a single workplace account.

Cashing out the 401k involves taking a lump-sum distribution directly. The entire amount becomes immediately taxable as ordinary income, significantly reducing savings and often incurring additional taxes.

Executing a Rollover

To maintain the tax-deferred or tax-free status of 401k funds, understanding specific transfer methods is essential. A direct rollover, also known as a trustee-to-trustee transfer, is the most common method. Funds are sent directly from the former 401k plan administrator to the new IRA custodian or 401k plan administrator, bypassing the account holder entirely to prevent tax complications.

Conversely, an indirect rollover involves the plan administrator issuing a check or direct deposit to the individual, who then has 60 days to deposit the funds into a new qualified retirement account. If funds are not deposited within this 60-day window, they are considered a taxable distribution. The former plan administrator is required to withhold 20% of the distribution for federal income tax, even if the individual intends to complete a rollover. The individual must then contribute funds from other sources to cover the full rollover amount.

To initiate a rollover, individuals must contact their former 401k plan administrator to request the necessary distribution forms. These forms require specific information, including the name and account number of the recipient IRA or new 401k plan, along with the receiving institution’s routing instructions. Accurate completion of these forms is important.

After submitting the forms, coordinate with both the former 401k administrator and the new account custodian to confirm transfer progress. Tracking the rollover via confirmation numbers or transaction IDs ensures successful fund movement and correct allocation. This follow-up prevents delays or errors.

Accessing Your Retirement Funds

Once retirement funds are settled in an IRA or a new 401k, individuals can begin accessing these savings, governed by specific rules regarding timing and method. Distributions from traditional retirement accounts can be taken without additional tax implications once the account holder reaches age 59½. Withdrawals before this age incur an additional 10% tax, plus ordinary income tax.

However, certain exceptions exist that may allow withdrawals before age 59½ without incurring the additional 10% tax. These exceptions can include distributions for unreimbursed medical expenses exceeding a certain percentage of adjusted gross income, qualified higher education expenses, or as part of a series of substantially equal periodic payments (SEPPs).

Required Minimum Distributions (RMDs) are mandatory annual withdrawals that individuals must begin taking from their traditional retirement accounts, including traditional 401ks and IRAs, once they reach a certain age. For individuals who turn 73 after December 31, 2022, the RMD age is 73. RMD calculation depends on the previous year’s account balance and the account holder’s life expectancy, as determined by IRS tables.

To request a distribution, individuals contact their plan administrator or IRA custodian and complete a distribution request form. The form specifies withdrawal amount, frequency (e.g., lump sum, periodic payments), and payment method. The plan administrator or custodian processes the request and issues funds as instructed.

Understanding Tax Implications

Tax consequences of 401k actions upon retirement are a significant consideration. Distributions from traditional 401ks and traditional IRAs are taxed as ordinary income in the year they are received. The withdrawn amount is added to other taxable income and subject to the individual’s marginal income tax rate.

Non-qualified distributions, particularly those taken before age 59½, incur an additional 10% tax on top of the regular income tax. This additional tax discourages early access to retirement savings, reinforcing their long-term purpose. The Internal Revenue Service (IRS) outlines specific circumstances under which this additional tax may be waived.

Direct rollovers, where funds are transferred directly between qualified retirement plans or to an IRA, are tax-free events. As funds move directly between retirement vehicles, no taxable income or taxes are due at transfer. This tax-free treatment makes direct rollovers the preferred method for moving retirement assets.

For indirect rollovers, the individual receives the funds, which must then be redeposited into a qualified retirement account within 60 days to avoid taxation. If not redeposited within this timeframe, the entire amount becomes taxable as ordinary income, potentially incurring the additional 10% early withdrawal tax. This strict timeline makes indirect rollovers less forgiving.

Qualified distributions from Roth 401ks and Roth IRAs are tax-free, provided certain conditions are met, such as the account being open for at least five years and the account holder being age 59½ or older. This contrasts with traditional accounts, where distributions are taxable. For all distributions, individuals receive Form 1099-R from their plan administrator or custodian, reporting the gross distribution and any taxes withheld. This form is used to report the distribution on the annual income tax return.