The rules for what to do with your 401 (k) after retirement can be tricky. While you should eventually start using your employer-sponsored retirement account, you have several options for withdrawing your money.
You can face penalties if you start spreading too early, so it’s important to know your options and the consequences they might have.
First, here are some ways to deal with your 401 (k) after retirement:
- Leave your 401 (k) to your old employer and start getting giveaways
- Roll it up in an IRA
- Cashing out (Beware of income tax and fees. More on this below).
Now let’s take a closer look at some of your post-retirement options for your 401 (k).
Leave 401 (k) to your employer and start regular distributions
If you don’t need money out of your 401 (k) right away, you can start receiving payments from it after you quit your job or retire. However, the rules for receiving giveaways differ depending on the type of account.
Traditional 401 (k)
With a traditional 401 (k), you can start regular distribution when you turn 59. Up to this age, all distributions are subject to a 10% penalty for early withdrawal. After the age of 59, you can start receiving payments without penalties. However, these distributions are taxed as ordinary income.
Mouth 401 (k)
The withdrawal rules are slightly different when working with the Roth 401 (k). Contributions to this type of account are made in dollars after tax and distributions are tax deductible. One of the key features of the Roth 401 (k) is that you can withdraw your deposited money at any time without penalties. However, you will still have to wait until 59 to avoid the early withdrawal penalty.
55 years rule
The only exception that may allow you to avoid early withdrawal penalties is the 55 years old rule. Under this rule, if you retire or otherwise lose your job, you can avoid a 10% early termination penalty if you are 55 or older. However, this rule also has caveats.
First, this only applies to 401 (k) sponsored by your last employer. 401 (k) that you had in a previous job are not eligible for this exception.
Also, if you transfer your last 401 (k) to an Individual Retirement Account (IRA), you will have to wait until age 59 and ½ to avoid early withdrawal penalties. Thus, if you are at least 55 years old but under 59 & ½ and you lose or quit your job, you can leave your last 401 (k) where it is currently.
Required minimum distributions
Let’s say you have a 401 (k) and haven’t started receiving payments after you retire. In this case, you must begin receiving the Required Minimum Payments (RMD) on April 1, following the calendar year in which you turn 72. The RMD’s age used to be 70 and a half, but has been increased to 72 with the SECURE Act.
RMDs are calculated using a table that matches your year-end account value and estimated years remaining in your life. In other words, the exact amount of your RMD will vary from person to person and from plan to plan.
Flip your 401 (k)
Converting your 401 (k) to an IRA is a great option because it can give you access to a wider world of investments. Keep in mind that if you have traditional 401 (k), it can only be collapsed in traditional Ira and you can only roll Mouth 401 (k) in Mouth Ira.
Employer-sponsored retirement plans such as 401 (k) often give members access to only a small number of mutual funds and can have high fees. But converting your 401 (k) to an IRA means access to individual stocks, bonds, and thousands of mutual funds and exchange-traded funds (ETFs) with potentially lower fees.
Learn more: How to determine your 401 (k) commission.
If the mutual funds available in your 401 (k) plan work for you, there is no need to renew. But if your investment options don’t fit your needs, it might be worth ditching them.
Converting your old 401 (k) to an IRA gives you more control over investments and fees.
How to flip your 401 (k)
If you decide to flip your 401 (k), there are a few steps you need to follow. This process will allow you to move it to the IRA in order to manage your investments and gain access to the full range of investment options.
Decide what type of account to open
The first step is to decide what type of account you want to open. You can roll your 401 (k) into either a traditional IRA or a Roth IRA. Tax implications may arise depending on your 401 (k) account type.
- If you drop the traditional 401 (k) at the Roth IRA, you will owe taxes on the carry-over.
- If you roll a Roth 401 (k) in a Roth IRA, taxes are deferred.
In other words, you can turn a traditional 401 (k) into a Roth IRA, but you incur taxes as a result.
Open your new account
The next step is to open your new account. Since you are transferring the account to IRA, you can transfer it to any broker you like. All popular online brokers offer IRA accounts. If you need more guidance, you can check out our list of the best brokers for IRA retirement accounts.
Ask your 401 (k) plan sponsor to renew
This is the step where you initiate rollover. You are contacting the plan sponsor and requesting a direct transfer. You will need to fill out several forms and then the plan sponsor can send a check for the full amount of the plan. Be sure to ask your sponsor to send it to the provider of your new account.
Select investment
Once your old 401 (k) balance reaches your new IRA, you can choose your investment. With your new IRA, you can choose from several investment options, including low-cost index funds and ETFs.
However, if you are overwhelmed by the process, you can use Capitalize to flip your 401 (k) for you. Capitalize is a free service that helps you choose a new retirement account and manages your documents for free.
Cash out
Acceptance of early refusal or out of your 401 (k) is not a sound financial decision. There are expensive implications for taxes and fees.
The IRS usually withholds 20% of the withdrawal amount to cover federal taxes. For example, if you take $ 100,000 early withdrawal from your 401 (k), you can only get $ 80,000, of which $ 20,000 will go towards taxes.
Another cost to consider is a 10% penalty for withdrawing funds from your 401 (k) before age 59 & ½. You will have to pay an additional 10%. So, using the example above, that’s another $ 10,000 that you will have to pay in the amount of $ 30,000 in taxes and fees.
Before starting early withdrawals from your 401 (k) fund, consider talking to a financial advisor to make sure you understand how much money you will have to pay in taxes and fees. A financial advisor can also take a look at your situation and suggest better alternatives to 401 (k) payments.
The essence
What to do with your 401 (k) after retirement? The two best options are either grab your distributions or roll them into an IRA.
Remember that early withdrawals from your 401 (k) have serious financial implications and are not a smart investment choice, so you should meet with a financial advisor to discuss your retirement plan before withdrawing any money. If you need help finding a financial advisor, check out our list of the best financial advisors on the Internet here.