What to do with your 401(k) when you retire

By the time you're ready to leave the working world for good, you may have quite a balance saved up in your 401(k). So what exactly should you do with all that money to help guarantee a well-funded retirement? Here are a couple of possibilities you might pursue (plus one you definitely shouldn't).

Put the money in a Roth IRA

A Roth IRA makes a nice complement to traditional, tax-deferred retirement savings accounts such as the 401(k). With your standard 401(k) you get a tax break on the contributions you make to the account, but once you retire and start taking money out, you'll have to finally pay the IRS the taxes on that money. A Roth account works the other way around: There's no tax break on your contributions, but the money you take out of the Roth account is tax-free. If you have both a tax-deferred and a Roth account, then once you retire you can choose how much to take out from each account every year in a way that minimizes your tax bill.

As an added bonus, Roth accounts are not subject to required minimum distributions (RMDs), so you have more control over your withdrawals if at least some of your money is in a Roth IRA.

Assuming that you haven't set up a Roth IRA in your working years, you can still do a Roth conversion and roll some or all of the money from your 401(k) into a brand-new Roth account. However, there's one big catch to a Roth conversion: The year you convert your retirement savings from a tax-deferred account to a Roth account, you have to pay taxes on all the money you converted. With a big balance to convert, this can lead to quite a horrendous tax bill, so your best bet is to decide how much money you want to move into the Roth account altogether and then split the conversion out over several years.

Put the money in a traditional IRA

401(k)s have significant advantages over IRAs during your working years because it's so easy to contribute to a 401(k) and because the resulting tax break is automatic. With an IRA, you can still get a tax break, but you have to claim it on your tax return as a deduction, which can be a bit of a hassle. But once you retire, the advantage shifts to the IRA. That's because IRAs have access to pretty much the entire world of investment options, while 401(k)s typically only have a few investments available to choose from.

What's more, the investment options in your 401(k) can change at any time based on decisions made by your former employers, while the investments in your IRA are entirely in your control. All in all, rolling over your 401(k) balance into an IRA after retirement makes a lot of sense.

Withdraw the money (don't do this!)

If you retire during or after the year you hit age 55, you can withdraw the money from your 401(k) without having to pay an early withdrawal penalty. However, you'd still have to pay income taxes on the money you withdraw just as though you'd made a Roth conversion (without the benefits of said Roth conversion). You'd also lose out on all the tax advantages of having your investments inside a retirement savings account, such as no capital gains taxes and no tax on dividends and interest when they come in.

Finally, withdrawing your money from your retirement savings accounts means you're much more likely to spend the money, potentially leaving you without enough funds to get you through your entire retirement. So resist the temptation to get your fingers on that money and keep it in some form of retirement savings account instead.

The $16,122 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,122 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.

The Motley Fool has a disclosure policy.