Most 401(k)s and other employer-sponsored retirement plans allow you to rollover your account into an IRA when you reach 59½ years of age.  The question is, should you?

Rollover vs. Withdrawal

There is some confusion surrounding this issue because the age most plans allow you to do a rollover coincides with the age the IRS allows you to make 401(k) withdrawals without incurring a penalty.  Other than age, one has nothing to do with the other.

A rollover is not a withdrawal, therefore it is not taxable event.  A rollover is the relocation of funds from one type of tax-advantaged retirement account to another.  You incur no taxes or penalties when you do a rollover*, and in terms of retirement planning it is not considered to be a mistake.

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A withdrawal, on the other hand, is a taxable event and it is considered a mistake.  When funds are withdrawn from your 401(k) before you reach 59½ years of age, a 10% penalty tax is assessed in the year the withdrawal is made.  On top of that, regardless of whether you are 59½ or not, the amount withdrawn will be taxed as ordinary income.  If paying tax on the amount withdrawn plus a potential penalty is not enough to keep you from taking early withdrawals, there's more:  When you make early withdrawals from your retirement savings, you are cheating yourself out of years of compound investment returns.  You may not have enough money to retire.

So in summary, rollover good, withdrawal bad.

In-Service 401(k) Rollovers

The "in-service" part of an in-service rollover doesn't mean you have to join the military, it means the rollover takes place before you retire and is not connected to any change in employers.  Normally rollovers occur when someone retires or moves from one employer to another.  An in-service rollover is a bit unusual in that neither of those events coincide with the rollover.  An in-service rollover is perfectly achievable as long as your 401(k) plan allows it.

Advantages of a 401(k)-to-IRA Rollover at 59½

The investment choices in most 401(k) plans are extremely limited compared to real-world investing.  The typical 401(k) offers a handful of mutual funds and the increasingly popular age-based investments where plans are selected based on your age or when you plan to retire.  Those are fine for the average American, but if you are an active investor or interested in becoming one, it is not the ideal situation.

The primary advantage of a 401(k)-to-IRA Rollover is that it opens the door to real-world investing.  You can invest in individual stocks, ETFs (exchange traded funds), bonds, or whatever you wish.  Instead of being limited to one transaction per month as with many 401(k) plans, you can buy and sell whenever you like.  Rolling your 401(k) into an IRA puts you in charge of your retirement savings.

401(k)-to-IRA Rollover: How it Works

Let's look at the mechanics of doing a 401(k)-to-IRA rollover.  First you need to check with your 401(k) provider to confirm they allow in-service rollovers for those age 59½ and older.  Next, choose an online broker such as Charles Schwab, Fidelity, or TD Ameritrade.  Create a traditional IRA account at the online broker of your choice.  Contact your new broker to determine the payable to and mailing address for 401(k) rollovers.  Then head back to your 401(k) provider to do the rollover.  You work with your 401(k) provider to push the funds to your new IRA account, not the other way around.  That is, you don't fill out a form at your new online broker to pull the funds from your existing 401(k).

Most financial institutions allow you to do a rollover online, or if you prefer you can call customer service.  However, you need to do a little homework before you do.  You want to rollover your vested, pre-tax balance.  Vested means you fully own it.  You always fully own your contributions, but if your employer matches a portion of your contributions, you are not vested in those until a period of time has elapsed.  Pre-tax means your 401(k) contributions are deducted from your paycheck before any taxes are assessed.  It's an important distinction because many employers offer Roth 401(k)s today and if you have made the switch some of your funds will be pre-tax from the normal 401(k) and some will be after-tax from the Roth portion.  Refer to your latest 401(k) statement to make these determinations.

Depending on the financial institution, your 401(k) provider will either mail you a check or mail it directly to your new IRA account.  If the check is mailed to you, do not sign it and get it to your new online broker immediately.  Funds removed from a 401(k) must be rolled over into an IRA within 60 days or the IRS will consider it a withdrawal and you will have to pay tax on the entire rollover amount.  Once the funds hit your new IRA, it takes about three business days for them to "settle", after which you are free to begin investing.

*Footnote:  In an attempt to avoid confusion, this discussion centers around conventional pre-tax 401(k) plans and maintaining the same type of account throughout the rollover process (i.e., moving funds from a pre-tax 401(k) to a traditional IRA).  This covers the majority of cases, however there are other possibilities.  If you want to rollover after-tax funds from a Roth 401(k), they need to be rolled into a Roth IRA.  It is also possible to change the type of account as part of the rollover process.  That is, you can roll a conventional pre-tax 401(k) into a Roth IRA, which is known as a Roth Conversion.  The catch is, you have to pay tax on the entire rollover amount in the year it occurs.  For example, if you have $200,000 in your 401(k) and you have an effective tax rate of 20%, you would owe $40,000 in taxes and likely more because it may bump you into the next highest tax bracket.

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