Rules about what to do with your 401(k) after you retire can be complicated. While you must eventually begin to draw down your employer-sponsored retirement account, you have a few options for how to withdraw your money.

You could face penalties if you take distributions too soon, so it’s essential to know your options and the implications they may have.

First, here are some of the ways you can handle your 401(k) after you retire:

  • Leave your 401(k) with your old employer and begin taking distributions
  • Roll it into an IRA
  • Cash out (Beware of income tax and fees. More on this below.)

Now, let’s take a closer look at some of your after-retirement options for your 401(k).

Leave 401(k) with Your Employer and Begin Taking Regular Distributions

If you don’t immediately need the money from your 401(k), you can begin taking distributions from it after leaving your job or retiring. However, the rules for taking distributions vary depending on the type of account.

Traditional 401(k)

With a traditional 401(k), you can begin taking regular distributions once you reach age 59 & ½. Before this age, there is a 10% early withdrawal penalty on all distributions. After age 59 & ½, you can begin taking distributions without a penalty. However, these distributions are taxed as ordinary income.

Roth 401(k)

Withdrawal rules are slightly different when dealing with a Roth 401(k). Contributions to this type of account are made with after-tax dollars and distributions are not taxable. One key difference with a Roth 401(k) is that you can withdraw the money you contributed at any point without a penalty. However, you will still have to wait until age 59 & ½ to avoid the early withdrawal penalty.

The Age 55 Rule

The one exception that may allow you to avoid the early withdrawal penalty is the age 55 rule. Under this rule, if you retire or otherwise lose your job, you can avoid the 10% early withdrawal penalty if you are at least 55. However, this rule, too, has caveats.

For one, it only applies to the 401(k) sponsored by your last employer. The 401(k) you had at your previous job won’t qualify for this exception.

In addition, if you roll your last 401(k) into an individual retirement account (IRA), you will have to wait until age 59 & ½ to avoid early withdrawal penalties. Thus, if you are at least 55 but younger than 59 & ½ and you lose or leave your job, you may want to keep your last 401(k) where it is for the time being.

Required Minimum Distributions

Suppose you have a 401(k) and haven’t started taking distributions after retirement. In that case, you must begin taking the required minimum distributions (RMDs) beginning on April 1st following the calendar year in which you turn 72. The RMD age used to be 70 & but increased to 72 with the SECURE Act.

RMDs are calculated using a table that corresponds to the account’s year-end value and the number of estimated years left in your lifetime. In other words, the exact amount of your RMD will vary from person to person and plan to plan.

Rolling Over Your 401(k)

Rolling over your 401(k) into an IRA is a great option because it can give you access to a wider world of investments. Keep in mind that if you have a traditional 401(k), it can only be rolled into a traditional IRA, and you can only roll a Roth 401(k) into a Roth IRA.

Employer-sponsored retirement plans like the 401(k) often only give participants access to a handful of mutual funds and may have high fees. But rolling your 401(k) into an IRA means having access to individual stocks, bonds, and thousands of mutual funds and exchange-traded funds (ETFs) with potentially lower fees.

Learn more: How to Determine Your 401(k) Fees.

If the mutual funds available in your 401(k) plan work for you, there’s no need to roll over. But if your investment options don’t meet your needs, it may be worth the switch.

Rolling your old 401(k) into an IRA gives you more control over the investments and fees.

How to Roll Over Your 401(k)

If you decide to roll over your 401(k), there are a few steps to complete. This process will allow you to move it into an IRA to manage your investments and access the full gamut of investment options.

Decide What Type of Account to Open

The first step is to decide which type of account you want to open. You can roll your 401(k) into either a traditional IRA or a Roth IRA. There may be tax implications depending on the type of 401(k) account you have.

  • If you roll a traditional 401(k) into a Roth IRA, you will owe taxes on the rolled-over amount.
  • If you roll a Roth 401(k) into a Roth IRA, taxes are deferred.

In other words, it’s possible to roll a traditional 401(k) into a Roth IRA, but you will incur taxes as a result.

Open Your New Account

The next step is to open your new account. Since you are moving the account to an IRA, you can move it to any broker you prefer. All the popular online brokers offer IRA accounts. If you’d like additional guidance, you can check out our list of the Best Brokers for IRA Retirement Accounts.

Ask Your 401(k) Plan Sponsor for a Rollover

This is the step where you initiate the rollover. You contact the plan sponsor and ask for a direct rollover. You will have to complete a few forms and then the plan sponsor can send a check for the full amount of the plan. Be sure to have the sponsor send it to your new account provider.

Select Investments

Once your old 401(k) balance reaches your new IRA, you can select your investments. With your new IRA, you can choose from a number of investment options, including low-cost index funds and ETFs.

If you are overwhelmed by the process, though, you can use Capitalize to roll your 401(k) over for you. Capitalize is a free service that helps you choose a new retirement account and manages the paperwork for free.

Cash Out

Taking an early withdrawal or a lump-sum distribution from your 401(k) is not a wise financial decision. There are expensive consequences in the form of taxes and fees.

It’s customary for the IRS to withhold 20% of a withdrawal to cover federal taxes. For example, if you take a $100,000 early withdrawal from your 401(k), you might only receive $80,000 with $20,000 going toward taxes.

The other cost to consider is the 10% penalty for taking a withdrawal from your 401(k) before age 59 & ½. You’ll have to pay an additional 10%. So, using the example above, that’s another $10,000 you’ll have to pay for a total of $30,000 in taxes and fees.

Before taking an early withdrawal from your 401(k) fund, consider speaking with a financial advisor to make sure you understand how much money you’ll have to pay in taxes and fees. A financial advisor can also take a look at your situation and provide better alternatives to a 401(k) cash out.

The Bottom Line

What should you do with your 401(k) after you retire? The two best choices are to either take your distributions or roll them into an IRA.

Remember, taking early withdrawals from your 401(k) comes with serious financial consequences and is not a wise investment choice so you should meet with a financial advisor to discuss your retirement plan before withdrawing any money. If you need help finding a financial advisor, check out our list of Best Online Financial Advisors here.