Many of us focus on our 401(k) as a major source of retirement funds throughout our careers. We calculate employer matches, we watch some of our paychecks funnel into each month, we follow all of the best practice advice for building up our 401(k) nest egg as best we can. But, once you've built that nest egg, and retirement comes knocking, what exactly should you be doing with that 401(k)? What's the best move to make? There are a few options…
There are essentially three things you can do with your 401(k) when you retire.
Transfer the Money to a Roth IRA
With a Roth account you won't pay taxes on your withdrawals when you eventually take the money out, but you have to pay taxes on the contributions you make. Normally that's not much of an issue, but if you take everything out of your 401(k) and put it into a Roth IRA you'll have to pay taxes that year on all the money you transfer. That can mean taking a big tax hit that year, but it's a one-time issue. Still it could be worth making the change, especially, if you really need to get the money out of your 401(k) for a specific reason.
To save money or make your tax bill easier, you can move money from your 401(k) to a Roth IRA over several years. That spreads out the tax bill, so you don't have to pay it all at once. In some cases, you can't keep the 401(k) when you retire, or it may not be offered at the new job if you change jobs. It has to go somewhere, and choosing the right option matters so you can protect your retirement funds. While you've worked hard to get and keep those funds, you have to continue to make the right choices to keep them where they need to be.
Transfer the Money to a Traditional IRA
Much like a Roth IRA, a traditional IRA can be a sound choice when you want to create a retirement plan for your 401(k). After you retire, an IRA is more advantageous than a 401(k) from a tax standpoint, and from an investment option standpoint. Typically, a 401(k) has a small number of investment choices, so they are very limited, which could hurt growth. Additionally, the things in which you invest are not in your control. But, with an IRA after retirement, you can control everything you invest in.
This can keep you from struggling with another person's potentially poor investment choices, and gives you back a good level of control over the money that is going to carry you through your retirement years. Investing that level of money is serious, and you want to make sure your retirement is well-funded. That is much easier to do with an IRA, and you can roll all of your money from a 401(k) over into that IRA relatively hassle-free so you will be protected financially.
Take the Money Out of Your 401(k)
If you aren't comfortable with IRAs or you need the money for something, you can simply take the money out of your 401(k) when you retire. But that's usually not recommended. You won't have to pay an early withdrawal penalty if you're at least 59 ½ (some cases 55), but you still have to pay income tax on the money you remove from your investment. It's like making a Roth conversion, except you don't get those benefits. You might also find that a lot of the money you took out will have to go to pay your taxes, and it's easy to spend that money if it's just sitting in your checking account. You don't want to spend too much of it, since it's supposed to be for your retirement.
People are living longer today, and that means you may need your retirement money to last longer than expected. Because of that, you need to be very careful. Taking it out and not making sure it's transferred to another investment vehicle properly could really put your retirement in serious jeopardy.
No matter how much love and attention you give your 401(k) during your working years, making the wrong moves with it when you retire can have a big effect on how valuable it is to you throughout your retirement years. As with any financial decision, there is no fool proof "best move". You and your financial advisor should sit down and discuss your options and make the "best move" for your unique financial situation.
This content created by Gary Scheer in conjunction with Fusion Capital Management.