What Should You Do With Your 401(k) When You Retire? A Strategic Guide to Retirement, Taxes, and Planning

If you’ve built a significant portion of your retirement savings in a 401(k), deciding what to do with that account when you retire is one of the most critical financial decisions you’ll face. This decision can significantly impact your long-term income, your exposure to taxes, and the fees you’ll pay throughout retirement.
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In this post, we’ll walk through the three main options for handling your 401(k) in retirement, the key planning considerations that come with each, and two powerful tax strategies that can help you save tens of thousands of dollars.

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Understanding Your 401(k) Retirement Options
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When you retire, you typically have three options for your 401(k):
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1. Leave the money in the plan
If your balance is above $5,000, most plans allow you to keep your funds in the plan. Accounts under $1,000 may be liquidated and sent as a check (a taxable event), while balances under $5,000 might be automatically rolled into an IRA.
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2. Roll over to a Traditional IRA or Roth IRA
You can roll your 401(k) into an individual retirement account (IRA), opening up more flexibility in investments and potentially lowering your fees.
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3. Cash out (Taxable Distribution)
This option involves taking the entire account as a lump sum. While it provides immediate access to your funds, it's rarely recommended due to the substantial tax consequences.
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Investment Options: 401(k) vs. IRA
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401(k) plans usually limit you to a menu of mutual funds—typically around a dozen choices. If your plan includes a self-directed account, you might access a broader range of investments.
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Rolling over to an IRA opens a wider universe of options: stocks, bonds, ETFs, CDs, annuities, and more. This flexibility is ideal for investors who want more control or who are working with a financial adviser for retirement planning.
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Fees and Expenses: Know What You're Paying
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The fees within your 401(k) will depend heavily on your employer’s size.
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• Smaller employers tend to have higher administrative, recordkeeping, and investment fees.
• Larger employers typically negotiate lower fees.
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You can find your plan’s fee details in your Summary Plan Description or Participant Fee Disclosure.
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IRAs usually have no administrative or recordkeeping fees at major custodians. However, the fees on investment products (such as mutual funds or ETFs) vary—some charge just a few basis points, while actively managed funds may exceed 1%.
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Services and Withdrawal Rules
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401(k) plans often provide limited services. After leaving your employer, you may not receive guidance on investments and could face paperwork hurdles with each transaction.
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One crucial aspect is withdrawal flexibility. Some plans do not allow partial withdrawals after retirement, potentially forcing you to take a lump-sum rollover—even if you only need a small distribution.
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IRAs, on the other hand, generally offer far more support tools, access to professional advice, and easier transaction processes. If you work with a financial adviser, they can help with retirement planning, tax-efficient withdrawals, and overall investment strategy.
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Tax Implications of Your 401(k) Decision
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Keeping your money in a 401(k) or rolling it into an IRA doesn’t trigger taxes. However, once you begin taking distributions, tax implications differ.
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401(k) Withdrawals
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• Require mandatory 20% federal withholding on distributions.
• Less flexible in terms of tax planning.
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IRA Withdrawals
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• Allow more freedom in setting your withholding—0%, 10%, or any amount.
• Better for tax optimization, especially if you use tax planning strategies.
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Cashing Out
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This comes with a full income tax bill on the entire amount. The 20% withholding is a minimum—you may owe more depending on your tax bracket.
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This is why cashing out is rarely the right move unless using it as part of a broader tax strategy.
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Creditor Protection Considerations
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401(k) plans benefit from federal protection under ERISA, meaning creditors can’t access that money in bankruptcy or legal judgments.
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Once you roll over to an IRA, state laws govern creditor protection. Most states extend protection to rollover IRAs, but if you’re a doctor, business owner, or otherwise exposed to personal lawsuits, it may be safer to leave funds in your 401(k).
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Tax Strategy #1: Rule of 55
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If you retire in the year you turn 55 or later, you can take penalty-free withdrawals from your 401(k) (though still subject to income tax). This is a major advantage over IRAs, which usually penalize withdrawals before age 59½.
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Important notes:
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• You must leave your employer in the year you turn 55 or later.
• The rule doesn’t apply if you roll the funds into an IRA.
• Some plans don’t allow partial withdrawals—check your plan’s rules.
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Tax Strategy #2: Net Unrealized Appreciation (NUA)
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If you own company stock inside your 401(k), NUA may be a game-changer for your retirement tax planning.
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Here’s how NUA works:
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• You move the employer stock into a taxable brokerage account instead of an IRA.
• You pay ordinary income tax only on the stock’s cost basis (original purchase price).
• The appreciation (gain) is taxed later at long-term capital gains rates—which are usually much lower than income tax rates.
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Example:
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• $100,000 in company stock with a $10,000 cost basis = $90,000 gain.
• You pay ordinary income tax on $10,000 now.
• Later, when you sell, the $90,000 gain is taxed at the capital gains rate.
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This could save you thousands in taxes, especially if you’re in a high-income tax bracket and your company stock has grown significantly.
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Planning Ahead for a Secure Retirement
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Making the right decision about your 401(k) during retirement involves understanding how fees, taxes, services, investment flexibility, and legal protections vary across options.
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Whether you choose to leave your money in the plan, roll it over to an IRA, or pursue advanced tax strategies like NUA or the Rule of 55, the key is aligning your choice with your broader retirement planning and tax strategy.
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And if this all feels overwhelming, consider working with a financial adviser who can build a retirement income plan customized to your goals, timeline, and tax situation.

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