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As you approach retirement, you may be wondering how you should handle your 401k account. There are several options depending on your other financial circumstances, your current age, and your tax situation. There are three basic 401k options at retirement. They include a lump sum distribution, leaving it with your employer, or an IRA rollover. The best decision for most people depends on your age at retirement and your tax situation.

Lump Sum Distribution

Anyone can choose to take a lump sum distribution from his or her 401k account. The 401k plan provider can cut you a check for the value of your account less 20% for mandatory federal withholding taxes. The 20% withholding will be used to pay any taxes due at year-end or be refunded if you owe no federal taxes. Any taxpayer whose age is less than 59 1/2 years at retirement will also incur a 10% penalty for early withdrawal. This penalty will also be withheld from the lump sum payment and is not used to pay federal taxes or eligible to be refunded. There are several exceptions to the 10% penalty age rule, and you should check with a tax professional to see if you qualify for any of them before you make a decision about early retirement.

Leave it With Your Employer

Any 401k account that is greater than $5,000 can be left with your employer. Many employers, however, restrict the investment choices you can make once you retire. You may be forced to invest your 401k in some percentage of company stock, a limited number of mutual fund options, exchange-traded funds, or a combination of these. These employer mandated investment options may not be the best option if you want your money to continue to grow. If you are older than 70 1/2 years, you have to take the required minimum distributions every year even if you choose to leave your 401k with your company.

IRA Rollover

If it is done correctly, you can roll your 401k account into an IRA account with no penalties. Most banks, investment companies, or equity firms have IRA rollover departments to help you with the transition. An IRA rollover allows you the most freedom to make investment choices. You can choose your level of risk and what types of equities you want as part of your IRA portfolio. An IRA can be invested in anything from safe treasury bonds to money market funds to riskier mutual funds. Depending on the IRA you choose, you can begin taking distributions at any time after age 59 1/2 years with no penalties. Most IRA distributions are taxed as regular income at the marginal tax rate. Once you reach age 70 1/2 years, you still have to take the required minimum distribution each year from your rollover IRA.

The best 401k option at retirement depends on your age, tax situation, and investment strategy. A lump sum cash distribution may be expensive in terms of taxes and penalties, but allows you to immediately use your money as you choose. Leaving it with your employer or rolling it over into an IRA lets you experience more tax deferred growth and spreads the tax burden over many years. However, these two options also include varying degrees of investment freedom, and may not allow you to easily access your money if you need emergency funds. The best decision depends on your other retirement income resources and your overall financial situation as you approach retirement.