What Happens To My 401(k) At Retirement?

You have been saving into your 401(k) for years, and are finally approaching retirement. What will happen to your account? What choices do you have, and what should you do?

You have been saving into your 401(k) for years, and are finally approaching retirement. What will happen to your account? What choices do you have, and what should you do? You actually have a couple of options, and several pitfalls to be aware of. Some of these pitfalls could cost you big time, so be sure to stay on top of them!


1. Rollover to an IRA

After you have officially separated from your employer, you can rollover your 401(k) to an IRA. Rollover just means that the money goes from one account to another without being taxed. If you have contributed to a Roth 401(k), the money can be rolled to a Roth IRA. Employer contributions and Traditional 401(k) contributions can be rolled to a Traditional IRA.

2. Leave your 401(k) alone

Many 401(k) plans allow you to leave your 401(k) with your old employer. This is the simplest option, because you don’t have to do anything. Evaluate the investment choices and fees within your 401(k) compared to rolling it over to an IRA. Usually it makes sense to do a rollover, but leaving it alone is certainly an option.

3. Take a distribution

You can take a full distribution from your 401(k). You will have to pay ordinary income tax rates on the distribution, and could be subject to penalties if done before age 55. This is the least attractive option for most people. It is usually better to spread the taxes across many years instead of paying them all at once.


1. Rolling over before age 59 ½

Did you know that you can take distributions from your 401(k) before age 59 ½ penalty free? If you retire/quit/get fired in the year you turn 55 or later, you can take distributions from your 401(k) with paying the 10% penalty; this is known as a 72(t) distribution. Money withdrawn from an IRA before age 59 ½ will be penalized. So if you are 57 years old and plan on taking some money out of your 401(k) before 59 ½, you may not want to do a rollover until you turn 59 ½.

2. Changing your mind about distribution

You have the option to take a full distribution from your 401(k). The employer is required by law to withhold 20% of the distribution for taxes. If within 60 days you decide that you should have put the money put into an IRA, you can do so penalty and tax free. The catch? You don’t get access to the 20% withheld for taxes, which means you have to come up with money to make up for that amount. Otherwise, you will get taxed on the 20% withheld for taxes, and could even hit with a penalty! Sometimes 401(k) administrators make a mistake and send you a check instead of your IRA, so this could happen accidentally. Be sure you instruct the administrator to rollover your 401(k) by sending the check directly to the custodian holding your IRA, and not to send you any money.

When you decide which option is best for you, just be sure to stay on top of the process. There will be a lot of paperwork, but you want to be sure nothing goes awry! So what do you think? Have you ever thought about what you will do with your 401(k) once you hit retirement? Feel free to share in the comments section!

Alan Moore is a fee-only financial planner and founder of Serenity Financial Consulting in Shorewood WI. Follow him on Twitter @R_Alan_Moore. You can contact him at alan@serenityfc.com, 414-455-5313, or visit his website at www.SerenityFC.com. Want more education? Download your free guide to the “10 Easy Steps To Securing Your Financial Future Today.”

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Nuitari (Grand Master Editor) December 04, 2012 at 01:59 PM
I've never heard of a Roth 401k. Generally, rolling a 401k into a Roth IRA carries a tax penalty does it not?
Alan Moore, MS, CFP® December 04, 2012 at 02:07 PM
Craig, thanks for the comment. Permanent disability waives the 10% penalty on both IRA's and 401(k)'s. With proper planning however, this would be avoided by having an emergency fund and long term disability insurance. That would allow someone to delay taking money out of the retirement accounts until retirement age. Social Security Disability has the most strict definition of "Disability" such that if you can work as a Walmart greeter, you probably won't qualify. This would certainly make you eligible for waiving the 10% penalty. Nuitari, generally if you roll a 401(k) to a Roth IRA you do have to pay income tax, but then the money grows tax free and there is no 10% penalty. Roth 401(k)'s allow you to save money into a 401(k), pay the taxes today (instead of taking a deduction) and it grows tax free. Here is a post on the topic: http://www.serenityfc.com/investing/roth-401ks-and-roth-iras-what-you-need-to-know/
Nuitari (Grand Master Editor) December 04, 2012 at 07:53 PM
Craig, I have a Roth IRA, but when I hear Obama wanting to have a taste of that now, I start to think all investing is hopeless.


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