What to Do with Your 401(k) When You Retire
You’ve been working for decades, dutifully putting away money into your company’s 401(k) plan and watching that investment grow into a sizable nest egg. You feel like you’ve finally nailed the savings game, but how comfortable are you with the idea of actually using and spending that money in retirement? The transition from saving to “drawing down” on retirement accounts is mysterious to a lot of people, and can be stressful as you rework your financial situation that may have been quite steady for a long time.
According to research from Cerulli Associates, one-fourth of 401(k) savers aged 45 and up had no idea what they will do with the account when they quit working and another quarter were going to put it in the hands of their financial advisor. Every situation is unique, but here are a few tips on how to make the best decision for yourself.
Review Your Company’s 401(k) Payout Policy
Company 401(k) plans vary widely in what they allow a previous employee to do. More and more employers are giving past workers the option to “pay out X dollars per month,” says Steve Vernon, author of Retirement Game-Changers and a research scholar at the Stanford Center on Longevity. Setting up regular withdrawals works well for many retirees, but some plans allow only lump-sum disbursements or partial withdrawals. If you need monthly withdrawals but your plan does not allow them, consider rolling it over into an Individual Retirement Plan (IRA). Here is a guide on how to roll over funds from a 401(k) to an IRA.
When planning for your retirement distributions you will want to assess the timing of your distributions in correlation to your current and future income tax bracket. The tax impact is one of the most important things to assess considering the result could negatively impact your tax liability by as much as 10% to 15%. Some of the variables to assess: current vs future marginal income tax bracket, capital gains tax bracket, taxable social security, estate and tax to inheritors. To put this into perspective, consider you are retired, and your taxable income is $100,000/yr. Then you had an unplanned expense, let’s say a new roof, that costs $10,000 and you need to make a withdrawal from your investment portfolio. Which account would you withdrawal from?
Tax Year 2021
Married Filing Jointly
Taxable Income $100,000
$10,000 Withdrawal from Taxable Brokerage account with $5,000 Long-Term Capital Gains.
Tax liability = $750
($5,000 * .15)
$10,000 Withdrawal from IRA or Pre-Tax 401(k)
Tax liability = $2,200
($10,000 * .22)
$10,000 Withdrawal from Roth or Post-Tax 401(k)
Tax liability = $0.00
The best decision is largely dependent on your personal finances and goals. Tax brackets and regulations are subject to change, so it is important to reevaluate the taxable impact of distributions at least annually.
Research Account Fees
Another reason you may want to consider switching to an IRA is for lower fees. Some 401(k) plans charge a hefty amount. Ask your employer for details on both investment expense ratios and plan administration fees. Ideally, your fees should range from 0.20% to no more than 1% with consideration of active management vs. index funds.
IRAs are often held at a brokerage firm, with minimal (or no) administrative fees and hundreds of products to choose from. Expense ratios for publicly traded assets are available on the internet, or you could call a broker to explore fees.
Many large companies have a decent variety of investment options in the 401(k), including ones that are low cost. But it is hard to beat an IRA for payout options, low fees or sheer number and kind of investment vehicles.
Another reason to choose an IRA is for consolidation. If you have multiple old 401(k)s and other savings accounts, you can roll them into a current or new IRA for ease of management. A financial advisor can help you make the best decision in this scenario regarding where to land the funds.
Your 401(k) options after retirement in a nutshell:
- Accessing your 401(k) works differently after retirement depending on your age.
- If you retire after age 59 1/2, you can take withdrawals without paying an early withdrawal penalty.
- You can choose not to take withdrawals and let the account sit, but you will not be able to make contributions.
- If you want to continue making contributions, you can roll the account over into an IRA.
- Both 401(k) accounts and traditional IRAs require you to take minimum distributions beginning at age 72.
You will want to figure out how much you will spend in retirement (here is the cost breakdown of an average retirement) and set up a budget. Then determine how much you will receive from a pension, if any, and how much you will get from Social Security. Once you have those numbers, you can determine what you will need to be taking out of your retirement account to make up the difference.
Most brokerage firms allow you to request distributions as you need them, whether monthly, quarterly or a on a different time schedule. And in the April following the year you turn 72, Uncle Sam will demand that you begin taking distributions according to a formula, whether you need the money or not. This is true for regular 401(k) plans and traditional IRAs, which benefit from pre-tax contributions. However, if you have a ROTH 401(k) or ROTH IRA, taxes have already been paid and you will have no required withdrawals. A financial advisor can counsel you about which accounts are beneficial for your specific needs.
The rules around 401(k)s are complex and vary from company to company, so it’s important for you, as an investor in that account, to have a working knowledge of how those policies affect you. If the policies or decisions are overwhelming to you, consult a Certified Financial Planner™ Professional. Remember, money management and financial planning doesn’t stop once you retire. In fact, how you save and spend in retirement may be the most critical time for you to have expert advice on your side. As people are living longer, needing skilled care and still wanting to leave something to their children or heirs, managing that money in retirement becomes even more critical.
At Tull Financial, our advisors will give you wealth management advice on a fee-only basis, meaning our fiduciary duty is to you and you alone. We also have a Certified Senior Advisor on staff to help our clients navigate life in retirement – beyond basic financial decisions. We’d love to talk to you about your long-term financial goals and how we can help you get “retirement ready.” Give us a call today at 888-296-7526.