I'm 55 with $400K: How to Maximize My 401k in Retirement?

Casey Weade: If you're watching this video, then chances are, you have a 401(k), and if you're like most pre-retirees, you have the majority of your life savings tied up in that 401(k), and now as you step into retirement, you want to know what your options are. Today, we're going to walk you through those options to make the most of your life savings.

Hey, I'm Casey Weade, CEO and Founder of Howard Bailey Financial, and also a Certified Financial Planner Practitioner. Today, we're answering the question, what do you do with your 401(k) when you retire? We're going to be taking a look at answering this by looking at the three options that you have.

We're going to walk through the three options that you have with that 401(k). Some of those pros and cons along the way, but most importantly, six key factors that you need to consider, as you're making this decision, and then we're going to talk about some nuances that are very important. If you think this is a simple answer, then I implore you to stick with me through the end, because there could be some very costly mistakes that we can help you avoid if we know these factors, and if we know these nuances. That's what we're going to focus on.

Let's start with the three different options you have with that 401(k). Number one, you can leave it alone. Number two, you can cash it out, or number three, you could roll it over to an IRA. If you leave it alone, you may or may not be able to leave it alone depending on the provisions of your particular plan. Most often, we find that individuals are forced out of those plans, and you may have to do something else.

Then, in that space, you're considering, "Do I cash it out and pay taxes, or do I roll it over to an IRA?" Most often, 9 times out of 10, 99% of the time, I would even venture to say, it does not make sense to cash out that 401(k), and pay a significant amount of taxes, if it's tax-deferred, or lose the tax-free growth benefits of the Roth, if it's tax-free, or if it's in the Roth portion of your 401(k).

That being the case, we most often want to consider leaving alone, or moving it to an IRA. We can do a tax-free rollover of those 401(k) funds over to an IRA, a traditional IRA, or we can move the other funds, the Roth funds, over to a Roth IRA, and we don't have to worry about paying any taxes. When you do this, I think it's vital and very important that you always try to do a direct rollover that is custodian-to-custodian, and you never take possession of the check, you never take possession of those funds, and that just helps you avoid some potential mistakes and pitfalls by doing that direct rollover. Try to do the direct rollover, if you decide that, that is the best thing for you.

Now, we've talked about these three different ways that we can do this. We can leave it alone, we can cash it out, we can roll it to a traditional IRA, or a Roth IRA. Now, let's talk about some of the key considerations that you need to be making, and those are sixfold. We're going to start by talking about cost. We're starting with cost, because it's important. Why do I say it's so important? Because studies and research show how important cost is.

Morningstar has put out past research showing us that cost is the number one determinant across in the investment world of your future returns, and the growth on your investments. We want to know what that cost is, and quite often, people will get it wrong when it comes to their 401(k), thinking they're not paying any fees, or they're paying very little in fees and expenses.

I can tell you that I've audited many a 401(k), where we've seen expenses of 2%, 2.5%, or even more than that. Now, 401(k) fees and expenses have come down considerably over the last decade, but it's not unusual today to still see fees and expenses inside of a 401(k) that's 1% to 2%, even 2% plus today. Where do those fees and expenses come from? Those can be administrative expenses, those can be charges by advisors that might be overseeing the 401(k) plan, even if you're not meeting with an advisor, there may be bookkeeping expenses, and of course, the investments themselves have a cost, and that's something that's often overlooked.

One of the things that you can do to uncover what all of these expenses are, is to meet with HR, or get a summary plan description, and even then, it's not all that easy to really understand all those expenses. One of the biggest areas of expense that we still see today is the individual investments that are made. Inside of each one of those mutual funds or exchange-traded funds, there's cost.

You think about the expense ratio, that's something you're probably familiar with. However, it's not just the expense ratio. Wall Street Journal did a study several years ago that illustrated that the cost inside of a mutual fund could be multiples higher than what's actually in the expense ratio, because there are expenses they don't have to disclose, such as trading costs.

Every time something is bought and sold inside of that mutual fund, there's a charge as it's going through a brokerage house, and those charges can be estimated based on the turnover inside of that fund, and they can get very, very expensive. We often like to audit that 401(k), do a little x-ray of the 401(k), if you will, and show you what those expenses are.

Now, if you roll that 401(k) over to an IRA, now you have a lot of options. You have a lot of different options to choose from, because you have the whole investment world to choose from. If you have a 401(k) with very low cost investment funds and ETFs, then maybe it makes sense to leave it to keep things simple. Maybe it makes more sense to roll those dollars over to an IRA, where you have a wider range of different options from a cost perspective.

Then, I want to talk a little bit about control. The control you have of that 401(k). What do by control? That might be a weird thing for you to consider. I've got my 401(k), I have control over those funds. How easy is it when you're actually working with that 401(k)? How much control do you really have? Because sometimes, it can be a little clunky inside of that 401(k).

Inside of that 401(k) you may have to submit paperwork for trades. It may be difficult to rebalance those different accounts. It can be a little bit of a headache if you have to go to HR, submit those forms on a regular basis. I think it's very important for us to try to simplify financial planning, and our financial lives as much as possible. If it's more difficult, it means we're less likely to do it.

Less likely to do the things that are going to benefit you the most in retirement. It's one thing for us to consider. Because if we look at the IRA world, we're going to find that, it's just a little bit more modernized today. It tends to be a little bit easier to work with. To do those rebalances. To make those trades. Even do Roth conversions for that matter.

Now, let's jump to number three, investment options. Now, I think this is a huge one for retirees, if not the biggest next to cost. That is, because on your way to retirement inside of that 401(k), your goals are pretty simple. You say, "Grow these dollars as fast as I possibly can. The lowest cost that I possibly can." We're just looking at growth at all costs. When you step into retirement, you often have goals that have shifted.

Maybe you're looking for more guarantees. Maybe you're looking for some guaranteed income, or some other fixed income options, or even looking to build a bond ladder inside of this 401(k). You can do that in an IRA. You have many more investment options. Literally thousands of different investment options. Both in the investment and the insurance world, for that matter.

Now, inside of your 401(k), you may have 10 to 20 different funds to choose from. You may have some really good fixed income options. Some really good money market options. You may have 30 or 40 different options inside of that 401(k). We want to consider all of those. Now, when you're doing that, you may say to yourself, "I don't know that I want a thousand different options. I don't know if I want the overwhelm that comes along with that many different options."

Maybe you're more likely to actually step into retirement, or manage those investments if you just don't have as many options, and it's less overwhelming. That's, of course, something for you to consider, as you're making this decision. Then, of course, we have consolidation. Why do we talk about consolidation? That is, and if you're someone's who's been with the same employer for 20 or 30 years, maybe this isn't much of an issue for you.

However, we do find regularly, meeting with individuals that have multiple 401(k)s. Sometimes a dozen different 401(k) plans. What's the problem with that? Well, it becomes a little overwhelming as well, and difficult to manage all of those different 401(k) plans. One of those things that can happen is overlap. You may have different funds in different places. The same fund here, and the same fund there. That creates a lot of portfolio overlap, and inefficiencies in the strategies. It's more difficult to rebalance a dozen, or a half a dozen different 401(k)s.

At the end of the day, we just want to know what we have. It may make sense to consolidate those different 401(k)s that you have into your current 401(k). It may make sense to start opening up another IRA. Maybe you leave your current 401(k) alone, and you take all those other 401(k)s and consolidate it into an IRA, where what you have. You know how all of those funds are invested, and you can see it all in one place to simplify your life. Maybe give you a little peace of mind along the way.

Ease of use. Now, ease of use, I think it combines a lot of these different factors. When it comes to 401(k)s, sometimes that ease of use like we talked about in the control area, isn't all of that easy. Now, when I think of ease of use here, I think one of the things that's really important for you to consider is asset location. What do by asset location? Once you step into retirement, you may have different assets, or investments that you want to allocate for different purposes in different buckets.

Maybe you want to maintain a 60-40 mix, but you want the fixed income to be allocated to your traditional IRA, and you want the equities to be allocated to your Roth IRA, because you're going to touch it second. Maybe you want to build a bond ladder. Maybe you want to open different accounts for different purposes, and build a bucket income strategy. If you want to do that, IRAs offer more flexibility.

You could set up different IRA accounts for different purposes, versus being inside of that 401(k)m you lose some of that flexibility to be able to specify, you want to take withdrawals from this fund, or take withdrawals from that fund. You may still be able to accomplish it. It just may be a little bit more difficult than what you can do in the world of IRAs.

Then, we get to coordination. When we talk about coordinating these accounts, what I mean is, building a retirement income strategy. We want to be able to coordinate, and create a withdrawal strategy in retirement, and that may mean that you want to actually have multiple different accounts, like we talked about in that ease-of-use space, and you want to have the ability to just do all of these different things.

We want to have different investment options in different places, maybe more expensive options in different places. We want to have a little bit more control, and we want to have some ease-of-use, and we want to be able to see our retirement income strategy all in one place, so we know each asset has a specific purpose that it's helping us accomplish. Maybe we have legacy assets.

Maybe we have our 12-month income bucket. Maybe we have part of it that makes up your emergency savings. We want to consider all of these different factors, as you're looking at the best thing to do with that 401(k). Leave it where it is, cash it out, or roll it over to an IRA. Now, whatever decision that you make, we're not done there. These may be the most important things that you get out of this video.

We have these four key considerations, and again, if you're enjoying the content, make sure you hit that "Like" button along the way. Now, when we take a look at these four key considerations, I say these are important, you're going to quickly know why I say that, because let's start with this, after-tax contributions. You may be making after-tax contributions or have made after-tax contributions to your 401(k), and this is vital for you to understand when you go to roll those funds over to an IRA, or a Roth IRA in this particular case.

Let's say that you're contributing $10,000 every year over the last 20 years on an after-tax basis to that 401(k). Now today, that would be worth about $400,000, if it grew at 7% per year, just a little bit more than that. You made $200,000 of that $400,000 as a contribution on an after-tax basis. You have an option with that 401(k) to roll the after-tax funds over to a Roth IRA, versus rolling those $200,000 in contributions over to a traditional IRA. That is vital for you to understand.

The other $200,000 in growth, unfortunately, has to go to a traditional IRA. I have seen this not happen automatically, or 401(k) providers not providing the answer that you need. It's important you know this when you start talking to your 401(k) provider about doing that rollover. Now, if you have the option of having in-service Roth conversions, or you have in-service conversions of the after-tax funds, then there's a couple things to consider here.

One, that is automatically happening for you. Those after-tax funds you're contributing are automatically going to a Roth portion of your 401(k). You also want to consider if you can do in-service Roth conversions inside of that 401(k). Many providers allow that to happen today. You can implement a Roth conversion strategy, while you keep those funds inside of the 401(k), but many don't at the same time. If you want to do Roth conversions in order to create a more tax-efficient retirement strategy, you may need to roll those dollars out to an IRA to do the conversions you want to do, in lieu of that retirement tax strategy.

Number three, age 55 distributions. I've probably seen more mistakes made here than anywhere else that we're going to talk about today. Once you reach the age of 55, if you separate from service after age 55 from your employer, and you take a distribution of that 401(k) in cash, you're going to be avoiding that 10% penalty that happens when you're under 59.5 with a traditional IRA.

If you were to roll those funds over to a traditional IRA, and take a distribution when you're 56, 57, 58, you would not only be paying taxes on the tax-deferred portion, but you would also be hit with a 10% penalty tax. If you're going to retire early, it often makes sense to at least leave some of the funds that are going to supplement your retirement income needs for you, or even use it as an overblown emergency fund or a backup fund, and leave some funds in that 401(k) to be there between the age of 55 and 59.5.

Lastly, we're talking about something known as NUA or Net Unrealized Appreciation. This is only going to pertain to those of you that have stock inside of your 401(k) employer stock. If you have stock inside of your 401(k), you have the ability to elect something called NUA. What that does for you, is allows you to roll that stock out of the 401(k) into a brokerage account.

When you do that, you only have to pay ordinary income tax rates on the cost basis. Anything above that is going to be taxed at long-term capital gains rates, regardless of when you sell the stock. It could be sold immediately. Those long-term capital gains rates, they range from 0% to 15%, 20%, even 23.8%, potentially, at their highest amount, if you have a very large distribution.

This could be very advantageous for you depending on what your tax bracket is. For the most part, those of you that have a very low cost basis, or have experienced a lot of growth in that employer stock over the years. Now, we've covered the six key factors, and four considerations for you to make, that have, hopefully, put you in a position to make more use, and better use of your hard-earned dollars, and help you make this decision, whether you're going to leave it alone, cash it out, or roll it over to an IRA, or a Roth IRA.

If you would like our team as fiduciary financial planners to sit down with you, and walk you through all these options, and run some numbers to see exactly what it's costing you, and see what those investment options are inside of that 401(k), outside of that 401(k), talk through retirement withdrawal strategies. We're offering you today a personal financial review. To take advantage of that, all you have to do is call the number on your screen. Our team is looking forward to visiting with you, as we visit with people across the country virtually, and also in person.