How Does A 401k Work When You Retire?

The first thing to consider is how a 401(k) works once you retire based on your retiring age. It also depends on what you plan to do with your 401(k) plan once you retire. There are several options for you to consider. Depending on your company’s rules, you could choose to take qualified distributions or continue to accumulate earnings until you are required to take distributions. You can also let it sit, roll it into an IRA or take only the minimum withdrawals required. Before you retire, you can also decide whether you want to invest your 401(k) or pay off your home. It’s entirely up to you.

It all depends on what you want to do during retirement and how much money you might need. But don’t forget, your age, your plans, and your desired retirement lifestyle matter. Let’s see more about these options.

Qualified Distributions

For those retiring after the age of 59 and a half, taking distributions from your 401(k) retirement account is allowed without having to pay the early withdrawal penalty of 10%. You should check your company’s rules as they might explain or limit this. Still, you might be allowed to withdraw regular distributions as annuities for a specific period or your expected lifetime, or you could take irregular distributions that don’t follow a pattern or lump-sum withdrawals.

These distributions, however you decide to manage them, will not affect your remaining balance. That will remain invested as your previous allocation decided, which is why your portfolio’s performance can affect the length of time over which you take payments out or the amount of the payments.

Something to keep in mind: traditional 401(k)’s qualified withdrawals benefits are constrained by your income tax rate because your contributions weren’t taxed. In contrast, a designated Roth account applies the income tax on your contributions, and withdrawals are tax-free. Roth accounts also allow distributions of earnings to be tax-free for those 59 and a half or older with an account at least five years old.

The age 55 Rule

The advantage of the age 55 rule allows you to withdraw distributions if you are 55 years of age, in early retirement, or lost your job, without the 10% early distribution penalty. This rule, however, can only be applied to 401(k)s from your last employer. If you have money left in another employer’s plan, that can not be accessed and nor can you access your Individual Retirement Account (IRA). This is why keeping the 401(k) close is essential, but it can also work as a safety limit if you spend too much, you still have a balance left at a past employer and the IRA.

Let it Rest

While you don’t have to take out distributions as soon as you retire, you can no longer contribute to your previous employer’s 401(k). However, your plan administrator will maintain your plan for investments higher than $5,000, and you can decide how to pick investments for your 401(k). Anything lower than that will trigger a lump-sum distribution. Once you retire, you might not immediately need to start withdrawals, and like that, your savings will continue to grow. While you don’t take any distributions from your 401(k), income taxes won’t be applied.

Required Minimum Distributions

You need to remember that a 401(k) compels you to take the required minimum distributions (RMD) by April 1st after you turn 72. Some companies allow you to refer that date till after you retire if you decide to retire after turning 72. If you wait for the RMDs to make withdrawals, you will be required to withdraw at least the RMD or make a plan based on life expectancy and account balance. You can not withdraw less than your RMD.

Continue Contributing

As we already mentioned, you can no longer contribute to your last employer’s 401(k) after you retire. Still, if you want to continue contributing, you can rollover your account into an IRA. Based on the new Secure Act, the IRA allows contributions for however long you want to keep contributing. 

The IRS does understand that this means that you will not retire completely, as further contributions mean further incomes after retirement. These can be salaries, wages, commissions, bonuses, tips, or net income from self-employment, all being taxable income. Contributions can not come from investments or social security.

In order to make an informed decision considering your 401(k) plan, consult the rules implemented by the IRS and the employer that set up your plan. You can also consult your company’s plan administrator and even talk to a financial advisor before any final decisions.