401(k) plans are employer-sponsored retirement plans. These plans allow you to defer some of your paycheck to an investment account. The investment account is tax-free and allows you to invest in a variety of mutual funds. When you retire, you must know how these accounts are paid out to you so that you can draw an income.
To receive payments from your 401(k) plan after retirement, you must contact your plan administrator through your employer's human resources department. Your plan administrator sends you a distribution form or a transfer request form based on your wishes. You may take distributions directly from the plan or you may move your 401(k) plan to an IRA. An IRA is an Individual Retirement Account not associated with your employer.
The significance of taking distributions from your 401(k) plan is that you don't have to move your money to receive payments. Mutual fund shares are cashed in and withdrawn as needed. The significance of moving your money through a transfer is that you must set up a new investment account. The IRA has all of the tax benefits of a 401(k) plan, but is not tied to your employer. Either way, you pay taxes on all distributions from traditional 401(k) plans and no income tax on Roth 401(k) plans.
The benefit of taking payments from your 401(k) plan after retirement is that you don't have to move your money to another financial institution. You may take a lump-sum distribution or you may take periodic payments. Either way, you have a great degree of control over how your retirement assets are paid out to you.
The disadvantage of receiving payments from your 401(k) plan is that the bulk of your savings remains invested in mutual funds. Your payments are dependent on the performance of the funds you're invested in. This is a disadvantage if you want more conservative investments since your fund choices may be limited in the 401(k) plan. Other accounts, like IRAs, often provide more investment options. These options range from bank CDs and fixed annuities to real estate investments and dividend-paying stocks.