What Should Retirees Do With Their 401(k)? Smart Moves for Your Nest Egg

After decades of stashing away money in your 401(k), you’ve finally reached the finish line – retirement! But now what? That account balance you’ve been building up for years suddenly needs to transform from a growing nest egg into actual income you can live on. If you’re scratching your head about what to do with your 401(k) after retirement, you’re definitely not alone

I’ve spent countless hours researching the best approaches to managing retirement accounts, and I’m excited to share these insights with you. The decisions you make about your 401(k) can significantly impact your financial comfort during your golden years.

Your Main Options When Retiring With a 401(k)

When you retire you’ve basically got four main paths to choose from for your 401(k) funds

1. Leave the money in your current 401(k) plan
2. Roll it over into an Individual Retirement Account (IRA)
3. Set up periodic withdrawals
4. Take a lump sum distribution

Let’s dive deeper into each option so you can figure out which might work best for you.

Option 1: Keep Your Money in the 401(k)

The Case for Staying Put

Keeping your money in your employer’s 401(k) plan after retirement isn’t just laziness – it can actually be a smart move in certain situations.

Benefits of keeping your 401(k) where it is:

• Familiar territory: You already know the investment options and how the plan works
• Potentially lower fees: Large employers often negotiate better fee structures than what you might get individually
• Legal protection: 401(k) plans typically offer stronger protection from creditors and bankruptcy than IRAs
• Early withdrawal benefits: If you retire at 55 or later, you can access your 401(k) funds penalty-free (the “Rule of 55”), whereas with an IRA you’d need to wait until 59½

As Morgan Hill, CEO of Hill & Hill Financial points out, “You don’t have to touch the 401(k) until you are 72.” And if you’re still working past 72 and don’t own 5% or more of the company, you might be able to delay required withdrawals even longer if your plan allows it.

Drawbacks to Consider

Before you decide to leave your money where it is, be aware of some potential downsides:

• Minimum balance requirements: Some plans won’t let you stay if your balance is below a certain threshold
• Limited investment options: Most 401(k) plans offer fewer investment choices than IRAs
• Ongoing plan fees: You’ll continue paying plan administration fees, which may be higher than what you’d pay elsewhere
• Less flexibility: You’ll have fewer options for withdrawals and distributions

Option 2: Roll Over to an IRA

Why an IRA Might Be Better

Rolling your 401(k) funds into an IRA is probably the most popular choice among retirees, and for good reason.

Advantages of an IRA rollover:

• More investment choices: IRAs typically offer thousands of investment options compared to the few dozen in most 401(k) plans
• Account consolidation: You can combine multiple retirement accounts into one IRA for easier management
• More withdrawal flexibility: IRAs generally offer more options for taking distributions
• Estate planning benefits: IRAs can provide more flexibility for naming beneficiaries

Mitchell Katz, a partner at Capital Associates Wealth Management, strongly advocates for this approach: “I would always advocate to roll it into an IRA. Typically, 401(k)s don’t have a big catalog of investment choices.”

The Process is Pretty Simple

Rolling over your 401(k) to an IRA is usually straightforward:

1. Open an IRA account with your chosen financial institution
2. Request a direct rollover from your 401(k) administrator
3. Choose your new investments within the IRA

The good news? A direct rollover from a 401(k) to an IRA is both penalty-free and tax-free.

Potential Downsides

However, an IRA rollover isn’t always the perfect solution:

• No early access at 55: With an IRA, you lose the “Rule of 55” benefit and must wait until 59½ for penalty-free withdrawals
• Less bankruptcy protection: IRAs don’t have the same level of creditor protection as 401(k)s
• Potentially higher costs: Depending on where you open your IRA, fees could be higher than your employer plan

Option 3: Set Up Periodic Withdrawals

If you need regular income from your retirement savings, setting up systematic withdrawals can be a great option. Most 401(k) plans and IRAs allow you to establish regular, automatic withdrawals on a schedule that works for you – monthly, quarterly, or annually.

This approach helps you:

• Create predictable income
• Keep the rest of your money invested and potentially growing
• Avoid taking too much too soon
• Potentially stay in a lower tax bracket

One popular strategy is the 4% rule, where you withdraw about 4% of your retirement savings in the first year and adjust for inflation in subsequent years.

Option 4: Take a Lump Sum Distribution

Taking all your money at once might sound tempting, but it’s usually not the best move for most retirees.

Why lump sums are usually problematic:

• Major tax hit: You’ll pay income tax on the entire balance at once, potentially pushing you into a much higher tax bracket
• Loss of tax-deferred growth: The funds no longer grow tax-deferred
• Temptation to spend: Having a large sum available can lead to faster spending
• Early withdrawal penalties: If you’re under 59½, you’ll face a 10% penalty on top of taxes

I typically only recommend lump sum distributions when the 401(k) balance is relatively small or if you have an immediate, crucial financial need.

Important Tax Considerations for Retirees

Understanding the tax implications of your 401(k) decisions is super important!

Required Minimum Distributions (RMDs)

Once you hit a certain age (currently 73), the IRS requires you to start taking minimum distributions from your traditional 401(k) or IRA. These are called Required Minimum Distributions or RMDs.

• Failure to take RMDs results in hefty penalties (50% of the amount you should have withdrawn!)
• RMDs are calculated based on your account balance and life expectancy
• Starting in 2024, Roth 401(k) accounts are no longer subject to RMDs

Tax-Smart Withdrawal Strategies

Here are some strategies to minimize taxes on your retirement withdrawals:

• Strategic income planning: Carefully plan which accounts to draw from each year to stay in lower tax brackets
• Roth conversions: Consider converting portions of your traditional 401(k) to a Roth IRA during years with lower income
• Qualified Charitable Distributions: After age 70½, you can donate up to $100,000 directly from your IRA to charity, which can satisfy RMD requirements without increasing taxable income

Comparing Your Options: A Quick Reference

Special Considerations Based on Your Age

Your age plays a huge role in determining your best 401(k) strategy:

If You’re Between 55-59½

If you retired in the calendar year you turned 55 or later, the “Rule of 55” lets you take penalty-free withdrawals from your current employer’s 401(k). This is a significant advantage over IRAs, which require you to wait until 59½ to avoid penalties.

If You’re Between 59½-73

This is your sweet spot – you can access your retirement funds without penalties, but you’re not yet required to take RMDs. This gives you flexibility to:

• Take only what you need
• Convert portions to Roth accounts
• Let investments continue growing tax-deferred

If You’re 73 or Older

Once you hit 73, RMDs kick in for traditional 401(k)s and IRAs. You must start taking these distributions whether you need the money or not (unless you’re still working and your plan allows delays).

Real Talk: Mistakes to Avoid

I’ve seen folks make some common mistakes when deciding what to do with their 401(k)s:

• Forgetting about old 401(k)s: Many people have multiple accounts from different employers
• Not comparing fees: Sometimes the differences in fees between options can significantly impact your retirement income
• Ignoring investment quality: Don’t just focus on fees – make sure you’re getting good investment options
• Rushing decisions: Take your time to understand all your options before making moves

Bottom Line: What’s Right for You?

There’s no one-size-fits-all answer to what retirees should do with their 401(k). Your best move depends on your:

• Age
• Financial needs
• Tax situation
• Investment preferences
• Estate planning goals

For many retirees, a combination approach works best – maybe rolling over a portion to an IRA while keeping some money in the 401(k) if it has particularly good investment options.

When in doubt, consulting with a financial advisor who specializes in retirement planning can be worth every penny. They can help you navigate these complex decisions and create a personalized strategy.

The good news is that you’ve already done the hard part – saving for retirement! Now it’s just about making smart choices to make that money last and support the retirement lifestyle you’ve worked so hard to achieve.

What’s your current thinking about your 401(k)? Are you leaning toward keeping it where it is or rolling it over? I’d love to hear your thoughts in the comments!