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What Should You Do With Your 401(k) After You Retire?

By Matthew Frankel, CFP® - Updated Jul 14, 2017 at 8:10AM

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After you retire, you have an important choice to make with your 401(k) account. Here are the options available, along with the pros and cons of each so you can determine which is best for you.

This article was updated on July 6, 2017, and was originally published on June 13, 2015.

If you're planning to retire soon and have a 401(k) or similar employer-sponsored retirement plan, then you have an important question to answer: what happens with your retirement nest egg? You could choose to leave your money in the plan, take a lump sum payout or partial withdrawal, buy an annuity, or roll the money over to an IRA. All of these options have their pros and cons, so let's see if we can figure out which is the best move for you.

The easiest option

Naturally, the easiest option is to simply leave your money in the plan. You can either begin taking withdrawals or wait and let your money continue to grow tax-deferred. Since you aren't required to begin taking withdrawals until the tax year in which you turn 70-1/2 years old, this could mean thousands of dollars in additional gains.

Jar of money with "retirement" on the label.

Image Source: Getty Images.

There are a few downsides to this approach. First off, you're limiting your investment choices to the assortment of funds offered by the plan. Some (but not all) 401(k) investment funds have rather high fees, and you may be able to do better elsewhere.

On the upside, it's worth noting that money in a 401(k) is generally protected from creditors and bankruptcy. So if either of these could be a concern at any point in your life, then it may be best to leave your account alone. Even money in an IRA doesn't get the same protection as 401(k) assets.

Guaranteed income for life may not be as good as it seems

One fairly popular option is to use the money to purchase an annuity, which basically means you'll receive a steady stream of income for the rest of your life in exchange for a large payment now.

Obviously, the upside to this is that you'll have a steady "paycheck" for as long as you live, and there is zero chance that you will outlive your money. There are several options when choosing annuities, including options that guarantee payments to your spouse or heirs if you die before a certain time. Here's a primer on annuities to help you get started if you want more information.

The major downside to an annuity is inflation. In other words, the payments you receive from the annuity will be worth less and less as time goes on. For example, if you buy an annuity that pays you $2,000 a month and the inflation rate averages 2%, those checks will have just $1,336 in purchasing power 20 years from now. You can find annuities with payments that increase over time, but this will cut down your initial income significantly.

Another thing you might want to consider is a deferred-income annuity. Even if you don't like the idea of sinking all of your retirement savings into an annuity, by putting some of it into a deferred-income annuity, you're essentially buying "insurance" against outliving your nest egg. Basically, you give a company a chunk of money now, and they agree to start making monthly payments to you once you reach a certain age, such as 80. Because of the delay, it may not cost much today to guarantee yourself enough money to live on when you get older.

Why not just take it all?

If you're over 55 and are no longer working, or are over 59-1/2 regardless of your employment status, then you can withdraw your entire account balance in one lump sum. However, this is rarely a good idea, especially if you have a large amount of money in the plan. In addition to losing the creditor protection I mentioned earlier, you could incur severe tax consequences, as the money you withdraw from a 401(k) counts toward your taxable income.

For example, if you have a 401(k) account with more than $418,401 in it (or more than $470,701 if you're married), a lump sum withdrawal could put you in the highest tax bracket (39.6%) for this year, even if you had no other income. This could take a serious and unnecessary bite out of your retirement savings.

Put yourself in the driver's seat

Finally, you have the option of rolling over your account into an IRA, which is my favorite option out of the four mentioned here.

With an IRA, you'll have the same tax treatment as leaving your money in the 401(k), but with more flexibility. Specifically, in an IRA you can invest in any stock, bond, or mutual fund you want, and even if you choose to stay in funds like those in your 401(k), you may be able to find lower-fee options through an IRA.

It's true that an IRA is likely to require a little more effort on your part than simply leaving the money where it is, but in my opinion, the gaining total control of how your retirement nest egg is invested is worth it.

What's the best choice for you?

The best action for your 401(k) depends on you, and there isn't just one right answer. I generally advise against taking a lump sum distribution unless you have a small amount of money in the plan. Meanwhile, putting all of your money into an annuity is usually not a good idea, but going this route with some of your 401(k) may not be the worst idea.

Finally, the best move for you might be a combination of a few of these options. For example, maybe you could take some of the money out right away to cover expenses and treat yourself, use some to buy a deferred-income annuity, and roll the rest into an IRA. The point is that there isn't a one-size-fits-all answer to the question of what to do with your 401(k), so it's important to weigh the pros and cons of each option and make the best decision for you.

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