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What to do with a 401(k) when you retire

Senior couple using a laptop while going through paperwork at home
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Thinking about what to do with a 401(k) when you retire? After years of contributing to your plan, it's time to make sure your balance is fully vested, plan for your distributions and figure out your tax implications.

Before you start making changes, be sure you understand what your 401(k) plan options are and how they work. There might be more decisions to make than you expected.

You have options for your 401(k) going forward

Upon reaching retirement, you have several choices about how to handle your 401(k) balance. It can seem overwhelming if you don't understand the options available or haven't planned in advance.

Your 401(k) options at retirement include:

  • Leaving the assets in the plan
  • Rolling the assets into a traditional IRA
  • Converting the assets into a Roth IRA
  • Taking a lump-sum cash distribution

The right option for you depends on your personal situation and goals. Each of these choices comes with its own set of pros and cons, so make sure you understand them and how your choice will impact your plan before you decide. Consider meeting with a financial advisor to discuss the available options and how each might suit your individual situation.

Adjust your portfolio mix to match your risk tolerance

Before you transition into retirement and are on a fixed income, it's wise to take the time to review your investment objectives and risk tolerance. They likely have changed considering the major life transition you are about to experience.

If the investment options in your 401(k) no longer support your objectives or align with your risk tolerance, you may want to convert it to an IRA. The investment options for 401(k)s are usually much more limited than those available in an IRA. Transferring may provide you with a better opportunity to structure a portfolio that is better suited to your financial needs.

Be aware of your employer's vesting schedule

The vested portion of your account balance is the amount that belongs to you. While your own contributions are always 100% vested, your employer's contributions may not be. Sometimes what your employer puts into your account vests, or becomes yours, according to a timeframe called a vesting schedule.

Some employers may have immediate vesting schedules, meaning their contributions are yours as soon as you receive them. Others may have a time requirement, such as years of service with the organization, before their contributions are fully vested.

It's important to know your employer's vesting schedule. If you leave your job before you are fully vested, a portion of the employer's matching contributions may be pulled back.

Plan distributions with tax implications in mind

Before withdrawing assets from a 401(k), take some time to review the distribution rules for your plan. While they are generally standard across all 401(k)s, there could be important nuances associated with your account.

Different distribution choices will trigger different tax liabilities or penalties. For example, withdrawing from a 401(k) or converting it to a Roth IRA are taxable events. However, transferring your balance to a traditional IRA would not trigger any taxes at the time of transfer.

If you are younger than 59½ and take money from your 401(k), you may incur a 10% penalty on taxable distributions. The IRS provides a special exception to this penalty if you terminate service with the employer in the calendar year you reach age 55 or after and decide to leave retirement assets in the plan.

Account for any outstanding loan balances

If you have an outstanding loan from your 401(k) plan, then you need to understand how it will be treated once your leave your job and enter retirement. Often, the plan will dictate that any outstanding loan balances have to be paid off within 60 or 90 days. Otherwise, the portion of the loan balance that you don't pay back will be treated as a distribution.

This could potentially throw your finances off track because not only will you have to pay taxes on that amount, but your savings balance will be reduced, too.

Update your beneficiaries if needed

You may think that designating a beneficiary is a one-time decision. However, plans and family dynamics can change. It's a good idea to review your beneficiary designations periodically and update them as necessary. This is especially important if you've experienced a marriage or divorce, have had a named beneficiary die or have new children or grandchildren you may want to add.

Your beneficiary designations won't transfer from your 401(k) to an IRA if you decide to move your account, so you'll need to be careful to ensure all of your accounts have the designations you want in place.

Learn who is responsible for paying retirement plan fees

There may be plan-level administrative and management fees associated with your 401(k) plan. It's important to understand whether the employer shoulders those fees or if they are assessed to the participants. It can make a significant difference in how much you are charged. You can find out by reviewing the plan's annual fee disclosure.

It's also a good idea to compare your 401(k) plan fees with those that may apply if you move the money into an IRA and factor that into your go-forward decision as well.

Keep other retirement details in mind

Your 401(k) plan is just one piece of your retirement puzzle. Retirees may want to plan for other important retirement considerations as well:

  • Longevity. People are living longer than ever, so your retirement resources may need to last awhile. When you consider how long you may live in retirement, it's better to err on the side of expecting to live a long time. If you live longer than you've planned, you may find yourself scrambling for resources. Not living quite as long as you've prepared for just means you'll leave a little extra for your heirs.
  • Health care. Incurring expensive health bills is one of the biggest concerns for Americans who are near or in retirement, rivaled only by outliving their savings. You can lessen your anxiety about having to deal with health events by incorporating advanced care in your retirement planning.
  • Investment diversity. The market always will be up and down, and it's important for you to be prepared to navigate these cycles during retirement. Throughout your life, you may have lined up other sources of guaranteed income to provide an extra layer of financial security. When you're thinking about how to manage your 401(k) after retirement, it's also a good time to check in on your whole financial picture.
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Get help with managing your retirement accounts

To make the smartest decisions, you may want to work with a financial advisor who can review your retirement plan and offer guidance to ensure the decisions you're making align with your ultimate goals. It's also wise to involve your beneficiaries in these important planning conversations, too, so they can understand the plan for your assets and distribution strategies.

Thrivent and its financial advisors and professionals do not provide legal, accounting or tax advice. Consult your attorney or tax professional.