There’s a reason why so many people invest their retirement savings in target-date mutual funds offered within their 401(k). These funds are designed to be simple: Your money is automatically invested in a mix of stocks, bonds, and other asset types based on your age and the year you plan to retire.
Written by Dan Rafter
As you get closer to your target date (the year you expect to hit retirement), the managers of your target-date fund gradually ramp down your risk — moving more of your dollars away from high-risk, growth-oriented investments like stocks, and focusing instead on safer, more conservative investments like bonds or cash. This “set it and forget it” approach allows you to easily stash money away for retirement without constantly rebalancing the fund yourself.
The goal is to have the right asset mix when your target-date fund hits its target but this leads to the big question: What do you do when your target-date fund finally does reach this endpoint?
Reaching the target date
According to the Investment Company Institute, the target date:
- isn’t a date when investors should automatically cash out their entire target-date fund.
- It’s simply an estimate of when investors will retire, and therefore stop making new investments in the fund. Most target-date funds can be kept open beyond the target date.
What happens when the fund reaches that target date depends on whether the fund is guided by one of two basic investing approaches.
- If a target-date fund has what is known as a “to” glide path, the fund manager will stop adjusting the fund’s asset mix once it hits the target date. In this scenario, your investment mix will remain in place until you cash out the fund.
- There’s also the “through” glide path. In this approach, the fund manager will continue to adjust the fund’s mix of investments even as the target date comes and goes.
It’s important to remember that target-date funds offer no guarantees. Your fund manager will rework your asset mix as your target date approaches to minimize your investment risk but no manager can guarantee any set amount of dollars by this date.
What can you do when your target date arrives?
When your target-date fund hits its target date, you have three basic choices of what to do with your money.
1. Do nothing
First, you can essentially choose to do nothing.
- You can instead leave your money in your target-date fund after you retire.
- You won’t be able to make new contributions to the fund, of course, but as with all 401(k) investments, your target-date fund will continue to grow on a tax-deferred basis. This will remain the case until you begin making withdrawals from the fund. You are required to begin taking your minimum withdrawals from your 401(k) by age 70 ½ at the latest.
2. Roll over funds into an IRA
If you want to be more hands-on with your investments, you can instead roll over the target-date fund, and any other investments in your 401(k), into an IRA.
- If you roll the money into a traditional IRA, you can continue to make contributions until you hit the year in which you turn 70 ½.
- If you roll your 401(k) funds into a Roth IRA, you can continue making contributions as long as you are earning income. If you are not working, though, and not earning income, you can’t contribute to a Roth no matter your age.
3. Cash out your fund
Finally, you can cash out your 401(k) (and the target-date fund within it) once you stop working for the employer who offered it to you.
- If you roll over your 401(k) into an IRA, you won’t have to pay taxes…
- If you cash out, you will owe income tax on the amount you withdraw from the plan.
- If you cash out before you turn 59 ½, you’ll have to pay income taxes and a 10% penalty.
The best option of the three depends on how much time you want to spend focusing on your investments.
- If you prefer to let others manage your investment, the “do-nothing” approach might be your best move.
- If you’d rather have more control, on the other hand, rolling over your target-date fund into an IRA is probably the better choice.
- If you need liquid cash immediately, cashing out your fund might be necessary — but the tax hit you’ll take often makes this the least attractive option.