RETIREMENT PLANNING  |  may 6, 2022

Helpful Options to Take Into Consideration for Your 401k at Retirement

These key considerations can help you decide whether to roll your 401(k) assets into an IRA or leave them in place.

 

Key Insights

  • Rolling assets from a 401(k) into an IRA when you retire isn’t your only option.

  • Your best decision depends on your financial situation and your 401(k) plan’s features.

  • Distribution rules are particularly important to keep in mind.

Roger Young, CFP®

Thought Leadership Director

Judith Ward, CFP®

Thought Leadership Director

As you prepare for retirement, you’ll need to decide what to do with the money in your 401(k) plan. “Typically, investors roll these assets into an individual retirement account (IRA) to continue to benefit from tax-advantaged growth,” says Judith Ward, CFP®, a thought leadership director with T. Rowe Price. “This is because some workplace plans may not allow you to leave your assets in the plan indefinitely and may require you to take all of your money at once as a lump sum.” Rolling over into an IRA also may provide you with more investment options to choose from and greater account flexibility.

However, many workplace plans are beginning to allow partial distributions, meaning retired investors can take out some of their money as needed and leave the remainder of their assets in their former employer’s 401(k) if they wish to do so. “Whether that’s the right decision for you will depend on the rules of your employer’s plan, as well as your personal financial situation,” says Roger Young, CFP®, a thought leadership director with T. Rowe Price. “Fortunately, your decision doesn’t have to be made on the day you retire,” says Young. “You can take your time to determine which approach will work best for your household before you begin drawing down your retirement savings.”

Employer Plan Considerations

As you consider your options, it’s important to understand your retirement plan’s rules about distributions. Answer these questions:

Does your 401(k) allow partial distributions?

If your 401(k) plan does not offer partial distributions and instead requires you to take a lump-sum distribution (everything at once) or specific periodic payments (installments on a regular basis), an IRA rollover provides substantially more flexibility by allowing distributions, generally, to be taken at any time. If your plan allows partial distributions, you may find it more convenient to leave your assets where they are. But there are other factors worth considering before you commit.

Does your 401(k) include Roth assets?

If you have both before-tax and Roth contributions in your 401(k) plan, you’ll also need to consider its distribution rules. Many plans may have specific requirements on the order of distributions from your before-tax and Roth assets. They may also require that you take distributions from both before-tax and Roth assets on a pro-rata basis. In other words, if you have a 401(k) that includes Roth contributions, your distributions would need to include funds from both the before-tax and Roth contributions based on the ratio of each type of asset in your account.

By contrast, if you have a Roth IRA and a Traditional IRA, you can simply take distributions from each account in whatever amounts make the most sense for your current situation. For example, you may want to rely more on your Traditional IRA early in retirement, reducing the amount of required minimum distributions (RMDs) you need to take later. Keep in mind that while RMDs do not apply to Roth IRAs, they do apply to Roth assets in a 401(k) account. Having control over the distributions of accounts with different tax characteristics may allow for more tax efficiency over the course of your retirement.

Does your 401(k) have the best investment options for your situation?

You should also evaluate the investment options available in your employer plan and compare them with those available through an IRA. IRAs typically offer a wider array of investment options than workplace retirement plans, meaning a rollover could give you a greater choice of investments while maintaining your account’s tax-advantaged status.

On the other hand, if you are satisfied with the investment options you have, you may want to consider leaving your assets in your current plan. Large plans that have access to institutional pricing typically offer investment options at a low cost. Be sure to keep the distribution rules for your workplace plan in mind, however. Similar to the pro-rata distributions between asset types described before, some plans may not let you specify which investments you sell with each distribution.

Your Personal Financial Situation

Consider other options that your current plan may offer as you weigh the advantages of each alternative. For example, if your plan offers annuitization options, it may be worth staying invested, particularly if a guaranteed income stream for your (and typically your spouse’s) lifetime is an important consideration. As you consider income streams, however, don’t forget to include Social Security benefits in your calculations. “Waiting to claim Social Security benefits is probably the most effective way to increase your guaranteed income,” says Ward. “The longer you wait, until age 70, the higher your monthly benefits will be.”

Keep financial flexibility and control in mind

You will need to start taking RMDs by April 1 the year after you turn 72. With an IRA, you have control over which funds you liquidate to cover any distribution you take, including RMDs. Your 401(k) may not give you as much flexibility. Check with your plan’s administrator to ensure you understand how your 401(k) handles RMD withdrawals, so you can factor that information into your decision-making.

Certain situations may merit special consideration

If you hold shares of highly appreciated company stock with an embedded capital gain (also known as net unrealized appreciation, or NUA) within your 401(k), it’s important to keep tax efficiency in mind (see “Making the Most of Highly Appreciated Company Stock”). And if you have taken out a loan against your 401(k), before initiating a rollover, you should check your plan’s rules about when it must be repaid. Some plans may require you to repay the loan immediately and in full, while others may allow a systematic payback.

Also, if you need to protect your savings from creditors, take a close look at your plan’s rules. Workplace retirement plans typically offer better protection from creditors than IRAs do.

The best decision for you

Ultimately, making the right choice depends on understanding the consequences of different approaches in the context of your unique financial situation. “It’s important to take the time to consider your options,” says Ward. “Make sure you weigh all the advantages and disadvantages of any approach against your specific needs.”

Making the Most of Highly Appreciated Company Stock

Holders of company stock with net unrealized appreciation (NUA) can make use of a strategy to minimize the tax impact.

If you hold a substantial amount of company stock in your workplace plan, it’s particularly important to take tax considerations into account when planning your retirement withdrawal strategy. One way to minimize the tax impact of NUA over the course of your retirement is to roll all your retirement assets except the company stock into an IRA. If your 401(k) contains Roth assets, you would roll those into a separate Roth IRA. For actual shares of company stock (as opposed to phantom or shadow stock), you would then execute an in-kind transfer of those shares from your 401(k) plan to a taxable brokerage account. It’s important to note that all of these transactions must take place during the same tax year.

At the time of the transfer, you would owe ordinary income taxes on the cost basis of the stock. Later, when you sell any of those shares, you will pay taxes on your investment gains at the long-term capital gains tax rate, which tends to be substantially lower than the ordinary income tax rate.

“If you hold highly appreciated company stock in a retirement plan, this factor could override other considerations when it comes to leaving the money in plan versus rolling it over,” says Young. “It can make a tremendous difference for some investors.”

Situations involving company stock can be complicated. It’s generally a good idea to talk to a trusted tax advisor or financial planner as you consider how to proceed.

Weighing Your Options

As you consider options for your 401(k) at retirement, keep in mind that the right choice for you depends on your unique financial situation and needs. While there are many more potential scenarios, the three examples below show how hypothetical investors proceeded based on their financial situation and plan features.

Weighing Your Options
  Financial Situation Plan Feature
Investor 1 Has $500,000 in his current 401(k). He decides to roll all of his assets into a Traditional IRA, which provides him more investment options to choose from and greater account flexibility compared with his workplace plan.
Investor 2 Has $500,000 in her current 401(k), $150,000 of which is in Roth assets. She chooses to roll the Roth assets in her account into a Roth IRA, giving her greater distribution flexibility, but leaves her before-tax savings in her current plan for now as she is satisfied with the investment options it offers at a low cost.
Investor 3 Has $500,000 in his current 401(k). He decides to leave his assets in his current plan for now due to convenience and because it allows partial distributions. He may revisit this in the future when he needs to start planning for RMDs.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of March 2022 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates. This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types; advice of any kind; or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision. Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Consider all available options, which include remaining with your current retirement plan, rolling over into a new employer’s plan or IRA, or cashing out the account value. When deciding between an employer-sponsored plan and an IRA, there may be important differences to consider—such as range of investment options, fees and expenses, availability of services, and distribution rules (including differences in applicable taxes and penalties). Depending on your plan’s investment options, in some cases, the investment management fees associated with your plan’s investment options may be lower than similar investment options offered outside the plan.

Past performance cannot guarantee future results. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.

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202203-2099819

 

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