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

Tim discusses retirement options for 401(k) accounts. He notes factors to consider like fees, investment options, and account consolidation. He outlines rules for withdrawing from retirement accounts before age 59.5, like the rule of 55. Also, understanding tax implications like asset placement and Roth conversions is essential for optimizing tax efficiency in retirement planning.

As individuals approach retirement, they typically hold various accounts, sometimes quite a few and sometimes scattered around. And they usually have a substantial portion of their savings in a tax-deferred company 401(k) plan.

Deciding what to do with these accounts when you retire is crucial for maximizing benefits and minimizing lifetime tax obligations. In today's video, I discuss your available options and factors to consider to make the best choice for your situation. Because failing to make an informed decision will likely result in paying higher taxes than necessary. 

3 Options for Your 401(k) in Retirement

For your 401(k), specifically, there are basically three options to consider when you retire: 

1. Leave it in place: You simply leave your funds at your former employer's 401(k) plan. But as you’ll see, this can be prohibitive.
   
   
2. Take a full cash distribution: This would mean withdrawing the entire balance of your 401(k) in cash. However, this option would incur significant tax liabilities, making it a bad choice for most retirees and defeating the purpose of funding a tax-deferred account in the first place, which was to save money in taxes. Because you were probably told to fund this account with pre-tax money thinking that your tax rate in retirement would be lower than it was while you were working. So, this one usually doesn’t make much sense.
   
   
3. Rollover or transfer to an IRA (or individual retirement account): This option allows for a tax-free transfer to a traditional IRA, preserving the tax-deferred status and preventing a taxable event. Also note, if your 401(k) has after-tax or Roth balances, you will want to roll those monies to a Roth IRA. Often, we see 401(k)s with both tax-deferred and after-tax money, so be mindful you’re getting those monies to the proper accounts. 

Factors to Consider with Retirement Accounts

Now, factors to consider when making decisions regarding your 401(k) and other accounts:

• Cost: As with anything, you want to consider costs. Determine the fees associated with your 401(k) plan and compare them with what they might be if you moved your money to an IRA. 401(k) plans often have fund fees, record keeping fees, admin fees, and other fees that aren’t very transparent, so you might have to do some digging and look at your summary plan description or maybe reach out to your HR to determine your total plan costs. But IRAs will have access to transparent, low-cost options.
  
  
• Investment Options: Typically, 401(k) plans offer limited investment choices, maybe between 10-40 options, maybe some target date funds, etc. When you enroll, you will see what options they have, and if you don't like what you see, too bad. And with an IRA you’re going to have a much broader and unrestricted range of investment opportunities, thus allowing for more flexibility and control over your portfolio. Some plans will have a “self-directed” option, and even though there’s usually hoops to jump through to use the self-directed option, it might be worth it while you’re still working because you will likely get a much wider array of investment choices, but once you retire, you might as well simply roll your funds to an IRA.
  
  
• Consolidation: As I mentioned, often, when I meet people, they may have accounts scattered around. It’s not unusual to have maybe 6, or 7, 8, or 9 different accounts. Maybe they have a few 401(k)s from different employers over the years, maybe a few IRAs, a couple of Roth IRAs, maybe a couple of taxable individual or joint brokerage accounts, maybe an inherited IRA, and so on.
  
  

  Managing all these accounts in retirement can be challenging, and consolidating your accounts will simplify tracking, tax planning, withdrawal planning, and investment management. Because, ultimately, we only have 3 account types anyway:

  1. Tax-deferred or pre-tax accounts, which will be your 401(k)s, 403(b)s, and IRAs; 
  2. Taxable, which will be your individual or joint brokerage accounts; and 
  3. We have tax-free or Roth accounts. 

  So there’s no reason to have 6+ accounts, unless you just like making easy things difficult. I am not one of those people.

• Accessibility: Traditional and Roth IRAs offer greater ease of management compared to employer-sponsored retirement plans. Having all of your accounts with one custodian is going to streamline tasks and make it easier to manage strategic decision-making. 401(k)s or any employer-sponsored plans are like giant trusts. And a trust is going to be more difficult to navigate than an individual retirement account.
  
  
• Net Unrealized Appreciation: Next, if you hold company stock in your 401(k) plan and have decent gains from when that stock was purchased, you’ll want to further explore the potential benefits of net unrealized appreciation. This means you could get the gain or appreciation on that stock moved to the preferable, lower 3-bracket long-term capital gains rates. So be aware of that before just moving 401(k) money to an IRA because this could save you quite a bit in taxes.
  
  
• Rule of 55: If you’re going to be 59.5 or older when you retire then you will have access to your retirement accounts penalty free. But if you are retiring somewhere between the age of 55 and 59.5, you might want to leave all or at least part of your savings in your company 401(k) because the rule of 55 lets you to withdraw money from your current 401(k) before age 59½ without paying the 10% penalty as long as the following are true: (1) Withdrawals occur in the year you turn 55 or later, (2) you have left your employer, (3) but you can’t have left your employer before you turned 55 and use this rule. So, basically you can’t leave your employer at 53, and then when you turn 55, use this rule. You have to be at least 55 when you left your employer.
  
  Obviously, the Rule of 55 and Net Unrealized Appreciation have additional nuance and complexities, so if those apply to you, you’ll want to do additional homework. 
  
  
• Rule of 72(t): There is also a way to access an IRA penalty free, using the Rule of 72(t), but it should be considered a very last resort, when all other options have been exhausted. It has even more nuance and complexity, so I’m simply going to mention that it does exist, but that’s as far as I’m going to go on that.
  
  
• Tax Considerations: Understanding the tax implications of different account types is essential. Proper asset allocation and location will help optimize tax efficiency. What do I mean by that? let's say you have an asset allocation of 60/40 meaning 60% equities to 40% bonds or fixed income. Well, for tax efficiency, you won’t want that same exact investment allocation in your 3 account types. You’re going to want to take asset location and withdrawal strategy into account and have your traditional IRA or pre-tax accounts invested one way, your Roth or tax-free accounts invested another way, and your brokerage accounts invested a different way based on your needs and goals. Also, Roth conversions will be much easier from an IRA account as opposed to a 401(k). 

Bottom line

Consideration of these factors is going to be crucial in determining the optimal strategy for managing your retirement accounts effectively.

A CERTIFIED financial planner™ professional can help you plan for your retirement. Schedule a call today so we can talk about your situation. 

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