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Taking 401(k) distributions in retirement

What to do with the money you've socked away in your 401(k).


When you retire, you have to decide what to do with your 401(k) money. Generally speaking, you will have some, if not all, of the following five choices: leave your money parked in the plan; take a lump-sum distribution; roll the money into an IRA; take periodic distributions; or purchase an annuity through an insurer recommended by the plan sponsor (i.e., your employer).

Keep in mind, not all employers allow retired workers to remain participants in their 401(k) plan, but if yours does, here's a quick look at the pros and cons of the various distribution options:

Lump-sum distribution

If you need a wad of cash right away, this option will serve that purpose. There are two key downsides: you forfeit the benefits of tax-deferred compounding by cashing out all at once; and you'll have to pay income taxes on your distribution for the tax year in which you take it, which can be a big bite out of your nest egg all at once.

Leave the money as is

Financial advisers often recommend retirees tap taxable accounts first in order to keep as much money growing tax-deferred as possible.

So if you're retiring and have money outside of your 401(k) that you plan to live on, you may leave your account untouched until you're 70-1/2. That's when Uncle Sam requires all retirees to begin taking mandatory annual distributions from their 401(k)s and traditional IRAs.

Of course, if your plan's investment choices are very limited or have performed poorly relative to their peers, you might be better off rolling the money into an IRA.

Rolling money into an IRA

This is the option often recommended by financial advisers since an IRA offers greater investment choice and control, and is especially recommended if your plan has few investment options and not very good ones at that.

If you're satisfied with your 401(k)'s investment menu, it has served you well and it provides enough diversity for you to reallocate your portfolio as needed in years to come, staying put may be a viable option.

The same is true if your plan offers a brokerage window, which lets you invest through a brokerage in funds and stocks that are not part of the plan's core investment options.

There are two advantages your 401(k) has over an IRA.

The first is protection from creditors. Money in a 401(k) cannot be touched in the event of personal bankruptcy or lawsuits. That's not necessarily the case with an IRA -- it depends where you live since some states offer partial protection of your IRA assets.

The second advantage is cost. Often with investments in a 401(k) plan, transaction fees and loads are waived. What's more, you may have access to mutual funds' institutional share classes, which charge lower annual expenses than the retail share classes you would buy through a broker for your IRA. However, if you have a financial adviser helping you with your IRA, you may be able to gain access to institutional shares that way.

If you have a string of retirement accounts when you leave the work force, you might be better served by consolidating your accounts into an IRA for two reasons: a consolidated account may be easier to manage in terms of administration and efficiency; and the larger your IRA account balance, the better your chances of qualifying for discounts on sales charges (a.k.a. break points) in mutual funds.

Also, in a 401(k) you have less control over the governance of your account, since you are subject to rule changes made by the plan sponsor within the confines of federal law.

Periodic distributions

If you're satisfied with your 401(k) plan and don't want to enter the wide world of investing through an IRA or simply want to avoid the hassle of changing accounts, you may be able to receive a regular stream of income from your 401(k).

Typically, plans let you select an amount to receive monthly or quarterly, and you're allowed to change that amount once a year, although some plans allow you to do so far more frequently, said David Wray, president of the 401(k)/Profit Sharing Council of America. If these payments are your main source of income, however, you have to be careful to manage your distributions so you don't outlive your dollars.

Annuities

Another way to receive regular payments is to buy an annuity based on some or all of your 401(k) account. Among the advantages: you receive guaranteed income for the rest of your life; you don't have to worry about how the source of that income is invested; and if you buy an annuity with survivor benefits, your spouse can receive a portion of your payments after you die.

The key drawbacks are that annuities are not inflation-adjusted; you may be able to generate a higher return investing on your own or with an adviser; and if you die soon after retiring, the insurance company, not your heirs, is more likely to benefit from the bulk of your savings. Top of page

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