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  • Writer's pictureThomas Schorn

Options for Your 401(k) When You Retire

Retiring is a big step. If that time has come, you are now facing an important decision: What should I do with my 401(k) balance?

There are multiple options, along with the pros and cons of each:

1. Stay with the Plan

Even though you may be leaving your employer, that does not mean that you have to take your 401(k) balance with you. Most retirement plans allow you to leave your 401(k) within the company’s plan even after you retire.

Pros: Leaving your balance within your old employer’s plan will allow you to maintain ERISA protections.

Additionally, many 401(k) plans hire investment managers to help participants make informed financial decisions. You would lose these services if you were to leave the plan without working with another financial professional.

Lastly, leaving your balance within the plan would keep the account invested in the market where you can lean on a long-term investment return on your money that will hopefully outpace inflation.

Cons: Although you will stay invested by leaving your 401(k) as is, if you do not roll over into an IRA, you will be limiting your investment options to those available within the plan. Similarly, you may not get the same freedom when it comes to distributions. Distributions differ on a plan-by-plan basis, but some retirement plans do not allow for scheduled or partial distributions, regardless of age or employment termination. Many people also overlook the difference in Required Minimum Distributions (RMDs) between Roth 401(k) and Roth IRA accounts. If you have a Roth balance in your 401(k), you can expect RMDs to start at age 72. In contrast, if you decided to roll over your 401(k) into an IRA, you would not have this same requirement.

Things to consider: Before making any decisions, compare and contrast your options. Specifically, look at the service level you are currently provided within the plan versus the level of service you can expect if you were to exit the retirement plan. Additionally, comparing the fees between rolling over your balance into an IRA and the expenses currently paid to stay in the retirement plan is essential.

2. Rollover to an IRA

A direct rollover from a 401(k) and into an IRA is a penalty-free and tax-free transfer. Like your 401(k), an IRA still receives tax-advantaged treatment from the IRS, along with other similarities.

Pros: By leaving your old company’s 401(k) plan and rolling over your balance into an IRA, you will have more freedom and flexibility over the distributions from your account. Also, you will likely increase your overall investment options while remaining invested. If you have an outside financial professional or advisor, you too will be able to receive personalized advice on the account while potentially consolidating accounts under one money manager.

Cons: A disadvantage of an IRA is that if you retire before age 59.5, you will not access your funds without a 10% early withdrawal penalty until age 59.5. In contrast, the “Rule of 55” allows 401(k)-plan participants who are between the ages of 55 and 59.5 to bypass the early withdrawal penalty as long as the account stays within the 401(k) plan. Furthermore, the ERISA protection that accompanies Qualified Retirement Plans, such as a 401(k), will not transfer to an IRA. Although IRAs are not ERISA-qualified, the funds are still protected from creditors under BAPCPA if you file for bankruptcy.

Things to consider: Again, it’s essential to compare the fees and costs associated with rolling your 401(k) into an IRA versus the expense to leave the account within the plan. It would be best if you also kept in mind your expected cash flow and distribution needs. As stated before, an IRA may allow for more control and flexibility, but keep in mind the “Rule of 55.” Many people also find the simplicity of consolidating accounts under one money manager or account appealing and rolling into an IRA allows you this opportunity.

3. Withdraw Your Balance

A third option allows you to withdraw from your account.

Pros: Generally, cashing out your 401(k) is not a good idea. A silver lining may be the access and liquidity of your funds, as they no longer are invested and are sitting in readily available cash.

Cons: Having your funds in cash ultimately means that you are no longer invested and will miss out on the potential of future investment return. Remember that a 401(k) account is to get you through retirement and not to retirement. By staying invested throughout retirement, you can expect your account balance to last longer than it would if it were to sit in cash even as you take distributions to cover your living expenses.

If you withdraw amounts from your 401(k), you will be liable to pay all taxes associated with the transaction. Depending on the size of account withdraw, this could lead to significant tax liability. If you are under the age of 59.5, you will also be subject to the 10% early withdrawal penalty.

Things to consider: If you are thinking about cashing out your 401(k), consult with your financial and tax professional. Usually, it makes more sense to roll over the account into an IRA or to leave the balance within your prior employer’s plan for the reasons given above. The ultimate tax liability, your age at retirement, and necessary investment growth to accommodate expected cash flow in retirement are things to keep in mind.

Making a decision on what to do with your 401(k) when you retire?

Fiduciary Planning can help you through your options and how they relate to your situation.

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