Whether or not to roll a 401(k) into an IRA when you are changing jobs or retiring early, does not have a simple yes/no answer. There are a number of factors to consider.
If your retirement plan includes retiring before you reach age 59 ½, you may not want to move your 401(k) into an IRA at all. It may be better to move it into your current employer’s 401(k) plan. Moving those funds into an IRA, may limit your withdrawal options in retirement, says Forbes in the article, “Should I Roll My Old 401(k) To An IRA If I Want To Retire Early?”
There’s a 10% penalty to withdraw funds from your traditional IRA before 59½, unless you qualify for an exception. However, many people don't know that the IRS lets employees who retire or otherwise leave a company at age 55 or older, to withdraw from their employer's plan without a penalty. Therefore, if you retire at age 55 and roll over your 401(k) to an IRA, you'll have to wait 4½ years longer to withdraw your funds without a penalty.
At any age, there will be income taxes to pay on withdrawals. If you have a traditional 401(k), you got a tax break when you invested. Your funds then grew tax-deferred all those years. The IRS now wants to tax your money. When you withdraw from your traditional 401(k), your funds will be taxed at ordinary income tax rates.
There are also some side benefits to staying with a 401(k), instead of opening up a rollover IRA. First, it simplifies your investments. If you roll your 401(k) to your current firm when you switch jobs, you know exactly what your funds are invested in and can check the balance all in one place. It could also protect you from legal judgments. Keeping retirement funds in a company plan, instead of an IRA, will keep it safe.
You should discuss your asset protection strategy with your estate planning attorney.
Remember, not everyone qualifies to invest in a Roth. However, it is possible to contribute to a Roth IRA in a roundabout way, called a "backdoor” Roth IRA. It is complicated and you will need to talk to your tax advisor. Basically, you can open a non-deductible IRA and contribute to it, up to the maximum of $5,500 (or $6,500 if you are over age 50), then immediately convert it to a Roth IRA. Because you haven’t earned any interest, you don’t have any taxes to pay on the conversion. Now you have a Roth IRA!
However, if you own any other traditional IRAs, you may have to pay pro-rata taxes on the conversion. If you want to try a backdoor Roth IRA, transferring your old 401(k) to your new employer’s plan may be the best way to go.
Speak with an experienced estate planning attorney to ensure that you don’t run afoul of any IRS rules on retirement accounts, if you intend to retire early. Making an expensive mistake could undo your early retirement.
Reference: Forbes (August 31, 2018) “Should I Roll My Old 401(k) To An IRA If I Want To Retire Early?”