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While you technically CAN take all of your 401(k) money out in a lump sum distribution upon retirement, it may not be in your best interest to do so. Not all employers allow retirees to remain active participants in their 401(k) plans, but if yours does, it is important to consider all your options. In addition to taking all your money out of a 401(k) account at once, you may also be able to:
If you are a skilled investor or have access to financial advice, a lump sum payment can help you:
In some cases, your employer’s 401(k) plan may require you to take the lump sum of cash – for instance, if you have less than $5,000 invested in the plan. However, there are options for what you can do with that money, and there is no rule preventing you from reinvesting.
There are a number of reasons NOT to take a lump sum payment. You could wind up with a huge tax bill, fail to make your money stretch as long as it needs to, or spend all of it in one fell swoop.
Rather than taking and keeping a 401(k) lump sum, you have four other options.
Financial advisers often recommend leaving as much money as possible in your account, where the money can continue growing tax-deferred with compounding interest. You can leave 100% of the account intact until age 72, when Uncle Sam requires you to take at least the Required Minimum Distribution each month. While you cannot continue contributing to a 401(k) held by a previous employer, your plan administrator is required to maintain your balance if you have more than $5,000 invested.
If your plan’s 401(k) investment choices are limited or have performed poorly, you may be better off directly rolling that money into an IRA now that it is free. A direct IRA rollover may also be a good idea if you retire before age 59.5, as it allows you to avoid the 10% early withdrawal penalty from the IRS. Thanks to the SECURE Act, you can now contribute to an IRA indefinitely.
There are two main advantages to leaving your money parked in the 401(k) as opposed to opening an IRA: money touched in the 401(k) cannot be touched by lawsuits or bankruptcy courts, and 401(k) fees are typically lower.
A 401(k) plan allows you the flexibility to receive monthly or quarterly distributions to cover your living expenses. You can typically change the amount at least once a year, though it depends on how your plan is written. Regular withdrawals are not subject to the 20% automatic withholding, but keep in mind that any non-Roth distributions will be taxed as regular income. Required Minimum Distributions kick in at age 72, with the amounts based on account balance and life expectancy.
Buying an annuity based on some or all of your 401(k) guarantees you income for the rest of your life. You don’t have to worry about how that source of income is invested, and your spouse can even receive a portion of the payments after your death. Unfortunately, annuities are not adjusted according to inflation, so you may find bigger returns working with an adviser. If you die soon after retirement, most of your money will go to the insurance company, rather than your heirs. You may not have as much bargaining power as an individual buyer, so you’ll have to choose your annuity provider and plan carefully to act as a true pension program.
Whether it’s best to take a lump sum or one of the other options depends on your personal goals and circumstances. Sometimes it’s best to talk with an expert one-on-one to determine the right course of action. Small business 401(k) plan provider Ubiquity offers retirement planning and financial wellness resources for both employers and employees to help our clients feel more secure in their futures.