What to Do With Your 401(k) When You Retire

When you leave your employer you have four choices for the 401(k): leave it where it is, roll it to an IRA, roll it into a new employer's plan if you keep working, or cash it out. Cashing out is almost always the worst option, because the entire balance is taxed as income in one year. The real decision is between leaving it and rolling it, and it is less obvious than either the plan provider or the advisor pitching the rollover will tell you.

Reasons to leave it in the plan, at least for now

If you leave your job in or after the year you turn 55, you can take withdrawals from that employer's 401(k) without the 10% early withdrawal penalty. Roll it to an IRA and that exception disappears until 59½. For anyone retiring between 55 and 59½ who needs income from the account, this alone can be the deciding factor.

Large employer plans sometimes offer institutional fund share classes with lower costs than a retail investor can get. Plans also have stronger protection from creditors under federal law than IRAs do in some states. And if you hold your employer's stock in the plan with a large gain, there is a tax rule called net unrealized appreciation that can be lost by rolling it over without planning.

Reasons to roll it to an IRA

An IRA gives you the full range of investments. For our clients this is usually the point: a 401(k) menu rarely allows a portfolio of individual dividend-paying companies, which is how we build retirement income. An IRA consolidates several old plans into one account, simplifies required minimum distributions, lets you name beneficiaries with more flexibility, and makes Roth conversions straightforward.

Two rules that trip people up

Do a direct rollover. Have the plan send the money straight to the IRA custodian. If the check is made out to you, the plan must withhold 20% for taxes, and you have 60 days to deposit the full amount, including the 20% you did not receive, or the shortfall is taxed as a distribution.

Separate pre-tax and Roth money. Many plans now have a Roth 401(k) portion. It must roll into a Roth IRA, not a traditional one, and after-tax contributions have their own rules. Get the breakdown from the plan before anything moves.

How we handle it

A rollover is not the first step in our process; the income plan is. Once we know what income the portfolio needs to produce and when, the decision about each account, including whether a 401(k) should move, follows from the plan. Sometimes the answer is to leave part of it in the plan until 59½ and roll the rest. We will tell you if leaving it where it is serves you better.

This article is not a recommendation to roll over any account. Consider all options and their fees, services, and protections before making a rollover decision. This article is for general education only and is not investment, tax, or legal advice. Investment advisory services are offered through Foundations Investment Advisors, LLC, an SEC-registered investment adviser. Investments involve risk, including possible loss of principal.