Additional Coverage:
- 9 Things Almost Every Retiree Gets Wrong When Rolling Over Their 401(k) (financebuzz.com)
Rolling over a 401(k) might seem straightforward-just move your money and pick a new account-but the process involves important details that many retirees overlook. Mistakes during a rollover can lead to unexpected taxes, penalties, or lost investment growth, jeopardizing your retirement security.
Here are the most common pitfalls retirees encounter with rollovers and how to avoid them:
1. Leaving rollover funds in cash
A rollover isn’t truly complete until your money is invested. According to Vanguard, 28% of investors who moved funds into an IRA in 2015 still had their balances sitting in cash seven years later.
Because IRAs don’t automatically invest like many 401(k)s, this oversight costs savers an estimated $172 billion annually in missed growth. Younger investors could lose roughly $130,000 by retirement age due to this delay.
2. Opting for an indirect rollover instead of a direct rollover
Indirect rollovers involve the distribution being sent to you, with the IRS requiring 20% withholding for taxes. For example, a $20,000 rollover check arrives as $16,000, and you must deposit the full $20,000 into a new account within 60 days.
Failing to do so results in the withheld amount becoming taxable income and possibly triggering a 10% early withdrawal penalty.
3. Missing the 60-day rollover deadline
If you don’t complete an indirect rollover within 60 days, the IRS treats the distribution as taxable income. For a $20,000 distribution in the 22% tax bracket, that means $4,400 in federal taxes, plus a potential 10% penalty ($2,000) if you’re under age 59½.
The IRS grants hardship waivers only in very limited cases-not for simple delays.
4. Accidentally rolling pretax 401(k) funds into a Roth IRA
Moving pretax 401(k) money directly into a Roth IRA is considered a taxable conversion, not a tax-free rollover. This means the entire amount is taxed as ordinary income that year.
For example, a $50,000 accidental conversion could trigger an unexpected $11,000 federal tax bill and potentially increase Medicare premiums down the line.
5. Doing more than one IRA rollover within 12 months
The IRS limits IRA-to-IRA rollovers to one per person every 12 months. Violating this rule turns the second rollover into a taxable distribution and incurs a 6% excess contribution penalty annually until corrected.
This restriction applies to all IRAs combined. To avoid this, use direct trustee-to-trustee transfers, which aren’t subject to the limit.
6. Overlooking the Rule of 55 before rolling over your 401(k)
The IRS Rule of 55 allows penalty-free withdrawals from a 401(k) if you leave your job in or after the year you turn 55. However, once you roll that money into an IRA, you lose this advantage because penalty-free withdrawals from IRAs only begin at age 59½.
Retirees planning early access to funds should consider this carefully.
7. Rolling over employer stock without considering Net Unrealized Appreciation (NUA)
If your 401(k) holds highly appreciated employer stock, rolling it all into an IRA could increase your future tax burden. Using NUA allows you to transfer the stock into a taxable brokerage account, paying ordinary income tax only on the original cost basis.
Future gains can then be taxed at lower long-term capital gains rates.
8. Not consolidating multiple old 401(k) accounts
Keeping old 401(k)s scattered across former employers complicates management. Consolidating these accounts into a single IRA simplifies investing, reduces paperwork, and makes it easier to monitor fees and performance.
It also lowers the risk of missing required minimum distributions or letting money sit idle.
9. Failing to update beneficiary designations
A rollover is an ideal time to review beneficiary designations, yet many overlook it. Retirement accounts pass according to the beneficiary form on file, not your will.
Outdated or incorrect beneficiaries can cause delays, legal disputes, or funds going to unintended heirs.
Bottom line:
Small mistakes during a 401(k) rollover can lead to costly taxes, penalties, or lost growth opportunities.
For most retirees, a direct trustee-to-trustee rollover is the safest method-it avoids mandatory withholding, eliminates the 60-day deadline, and reduces tax risks. Always confirm how your new account will invest the funds and understand any changes to your withdrawal options before moving your savings.
Additional money tips for everyone:
No matter your financial situation, there are steps you can take to strengthen your finances:
- Increase your income: Explore side hustles or other ways to supplement your earnings without interfering with your main job.
- Grow your wealth: Take advantage of time and compound interest.
Know your financial standing and consider working with a professional to plan for early retirement.
- Maximize savings: Use senior discounts, shop around for the best car insurance rates, and avoid hidden money drains that quietly erode your budget.
Being mindful and informed about your retirement accounts and finances can make a significant difference in achieving a comfortable and secure retirement.
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- 9 Things Almost Every Retiree Gets Wrong When Rolling Over Their 401(k) (financebuzz.com)