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The way your 401(k) plan works after you retire depends on what you do with it. Depending on your age at retirement—and the rules of your company—you may elect to start taking qualified distributions. Alternatively, you may choose to let your account continue to accumulate earnings until you are required to begin taking distributions. Another option is to convert your company-sponsored 401(k) into a more flexible individual retirement account (IRA).
Key Takeaways
- How your 401(k) works after retirement depends in large part on your age.
- If you retire after 59½, you can start taking withdrawals without paying an early withdrawal penalty.
- If you don’t need to access your savings just yet, you can let it sit—though you won’t be able to contribute.
- In order to keep contributing, you’ll need to roll over your 401(k) into an IRA and have earned income you can add to the account.
- With both a 401(k) and a traditional IRA, you will be required to take minimum distributions starting at age 72.
401(k) Withdrawal Age
Tax-advantaged retirement accounts, such as 401(k)s, exist to ensure you have enough income when you get old, finish working, and no longer receive a regular salary. You may from time to time be eager to tap into your funds before you reach retirement. However, if you succumb to those temptations you will likely have to pay a hefty price—early withdrawal penalties have been put in place to discourage such behavior.
Most Americans retire in their mid-60s. There’s a little more flexibility offered with retirement savings plans, though, including the company-sponsored 401(k). The Internal Revenue Service (IRS) allows you to begin taking distributions from your 401(k) without a 10% early withdrawal penalty as soon as you are 59½ years old.
Early Withdrawals: The 401(k) Age 55 Rule
If you retire—or lose your job—when you are age 55 but not yet 59½, you can avoid the 10% early withdrawal penalty for taking money out of your 401(k). However, this only applies to the 401(k) from the employer you just left. Money that is still in an earlier employer’s plan is not eligible for this exception—nor is money in an IRA.
Nashville: How Do I Invest for Retirement?
Taking 401(k) Distributions
Depending on your company’s rules, you may elect to take regular distributions in the form of an annuity, either for a fixed period or over your anticipated lifetime—or to take non-periodic or lump-sum withdrawals.
When you take distributions from your 401(k), the remainder of your account balance remains invested according to your previous allocations. This means that the length of time over which payments can be taken, and the amount of each payment, depends on the performance of your investment portfolio.
Taxation
If you take qualified distributions from a traditional 401(k), all distributions are subject to ordinary income tax. Contributions were deposited from your paycheck before being taxed, deferring the taxation process until the withdrawal date. In other words, when you eventually tap into your traditional 401(k) funds, distributions will be treated as taxable earnings for that year, on top of any other money you made.
If, on the other hand, you have a designated Roth account, you have already paid income taxes on your contributions, so withdrawals are not subject to taxation. Roth accounts allow earnings to be distributed tax-free as well, so long as the account holder is over 59½ and has held the account for at least five years.
Keeping Your Money in a 401(k)
You are not required to take distributions from your account as soon as you retire. While you cannot continue to contribute to a 401(k) held by a previous employer, your plan administrator is required to maintain your plan if you have more than $5,000 invested. Anything less than $5,000 will trigger a lump-sum distribution, but most people nearing retirement will have more substantial savings accrued.
If you have no need for your savings immediately after retirement, there’s no reason not to let your savings continue to earn investment income. As long as you do not take any distributions from your 401(k), you are not subject to any taxation.
If your account is between $1,000 and $5,000, your company is required to roll the funds into an IRA if it forces you out of the plan—unless you opt to receive a lump-sum payment or roll it over to an IRA of your choice.
Required Minimum Distributions
While you don’t need to start taking distributions from your 401(k) the minute you stop working, you must begin taking required minimum distributions (RMDs) by April 1 following the year you turn 72. Some employer-sponsored plans may allow you to defer distributions until April 1 of the year after you retire, if you retire after age 72, but it is not common. Keep in mind that this exception does not apply to plans you may have with previous employers that you no longer work for.
If you wait until you are required to take your RMDs, you must begin withdrawing regular, periodic distributions calculated based on your life expectancy and account balance. While you may withdraw more in any given year, you cannot withdraw less than your RMD.
The age for RMDs used to be 70½, but following the passage of the Setting Every Community Up For Retirement Enhancement (SECURE) Act in Dec. 2019, it was raised to 72.
Convert to an IRA and Keep Contributing
You cannot contribute to a 401(k) after you leave your job, so if you want to continue adding money to your retirement funds you’ll need to roll over your account(s) into an IRA. Previously, you could contribute to a Roth IRA indefinitely, but could not contribute to a traditional IRA after age 70½. However, under the new SECURE Act, you can now contribute to a traditional IRA for as long as you like.
Keep in mind that you can only contribute earned income to either type of IRA, so this strategy will only work if you have not retired completely and still earn “taxable compensation, such as wages, salaries, commissions, tips, bonuses, or net income from self-employment,” as the IRS puts it. You can’t contribute money earned from investments or from your Social Security check, though certain types of alimony payments may qualify.
To execute a rollover of your 401(k), you can ask your plan administrator to distribute your savings directly to a new or existing IRA. Alternatively, you can elect to take the distribution yourself. However, in this case, you must deposit the funds into your IRA within 60 days to avoid paying taxes on the income.
Traditional 401(k) accounts can be rolled over into either a traditional IRA or a Roth IRA, whereas designated Roth 401(k) accounts must be rolled into a Roth IRA.
Traditional IRA vs. Roth IRA
Like traditional 401(k) distributions, withdrawals from a traditional IRA are subject to your normal income tax rate the year in which you take the distribution.
Withdrawals from Roth IRAs, on the other hand, are completely tax-free if they are taken after you reach age 59½ and see out a five-year holding period. However, if you decide to roll over the assets in a traditional 401(k) to a Roth IRA, you will owe income tax on the full amount of the rollover—with Roth IRAs you pay taxes upfront.
Traditional IRAs are subject to the same RMD regulations as 401(k)s and other employer-sponsored retirement plans. However, there is no RMD requirement for a Roth IRA, which can be a significant advantage during retirement.
Can I Take All My Money Out of My 401(k) When I Retire?
You are free to empty your 401(k) as soon as you reach the age of 59½, or 55 in some cases. It’s also possible to cash out before, although doing so would normally trigger a 10% early withdrawal penalty.
If you want to cash out everything, you can opt for a lump-sum payment. Think carefully before taking this approach, though. Withdrawing your savings all at once could result in a hefty tax bill and, if not managed wisely, leave you living in severe poverty later on in retirement.
How Long Does It Take to Get a 401(k) Distribution?
Times can vary, depending on who administers the account. For a more precise timeframe, contact the HR department of the company you worked for or the financial institution managing the funds.
What Are My 401(k) Options After Retirement?
Generally speaking, retirees with a 401(k) are left with the following choices: leave your money in the plan until you reach the age of required minimum distributions; convert the account into an IRA; start cashing out via a lump-sum distribution, installment payments, or by purchasing an annuity through a recommended insurer.
The Bottom Line
Rules controlling what you can do with your 401(k) after retirement are very complicated, shaped both by the IRS and by the company that set up the plan. Consult your company’s plan administrator for details. It may also be a good idea to talk to a financial advisor before making any final decisions.
