What Are the Benefits of Rolling a 401(k) to an IRA?

Rolling your money from a 401(k) plan into either a traditional or Roth individual retirement account can allow you to cut the final strings with your company. However, you can only roll over money from your 401(k) plan to your IRA after you've left your job or turned 59 1/2 years old. Don't try to skirt the rules by taking a hardship distribution, because those aren't eligible to be rolled over.

Continuing Tax Deferral

If you empty your 401(k) plan, you must pay taxes on that money in the year you take it out. Plus, any income earned on the money in the future is taxable when you earn it. Rolling your money into a traditional IRA allows you to avoid this because you continue to defer taxes on the money until you take distributions from the traditional IRA. In addition, if you have a sizable 401(k), spreading your future distributions from the IRA over several years or longer can help keep you in a lower tax bracket.

Convert to Roth

If you're paying a lower tax rate than you anticipate paying in retirement, you can convert the money in your 401(k) plan to a Roth IRA. Yes, you have to pay income taxes on the conversion, but your qualified distributions will come out tax-free later on. If your employer doesn't offer a Roth 401(k) plan, making the conversion to a Roth IRA lets you start saving on an after-tax basis. For example, if you've taken the year off from work and have minimal other income, your tax rate might be lower that year, making a Roth IRA conversion very attractive.

Investment Control

Depending on your employer's 401(k) plan, you might feel a bit restricted in your investment options. If your plan doesn't offer investments you like, you're stuck. When you roll the money to an IRA, you have total control over your financial institution and your investment choices. The only prohibited investments in IRAs are collectibles such as paintings, alcoholic beverages and gems, as well as investments for your own benefit, such as a vacation home or business you operate.

Early Withdrawal Exceptions

Depending on your age and financial circumstances, you might find that IRA early withdrawal penalty exceptions more favorable. For example, early withdrawals from IRAs aren't penalized if you use the money for higher education expenses such as your child's college tuition. Even if your 401(k) plan allowed you to take a hardship withdrawal, you'd still owe the early withdrawal penalty. You can start using the IRA early withdrawal penalty exceptions immediately after you roll over. Of course, if you're already 59 1/2 years old, this point is moot because you can take qualified distributions for any reason.