As per USA Facts, about 46% of American households have savings in retirement accounts, such as 401(k)s, IRAs, or pensions. As of December 2022, the United States’ retirement plans and accounts held $37.8 trillion. This includes $26.3 trillion in employer-sponsored plans and $11.5 trillion in Individual Retirement Accounts (IRAs).
Rolling over your retirement funds can be a smart financial move—if done correctly. But a simple mistake can cost you thousands in taxes, penalties, or lost growth. Financial advisors emphasize the necessity of making knowledgeable choices regarding transferring your accumulated savings. Avoid these 15 costly mistakes.
Cashing Out Instead of Rolling Over
Taking a lump sum from your retirement account instead of rolling it over can result in substantial taxes and penalties. The IRS considers this a withdrawal, meaning you could owe income taxes on the full amount. Retirement account holders under age 59½ will incur an additional 10% early withdrawal penalty.
That’s a big hit to your savings and future growth. Transferring retirement funds directly into another account prevents unnecessary financial setbacks.
Not Using a Direct Rollover
As the IRS explains, a direct rollover moves your retirement savings from one account to another without you ever touching the money. When you request a check made out to you, the IRS will withhold 20% of the amount for taxes regardless of your intention to deposit it into another retirement account.
The IRS will tax the unpaid funds and potentially penalize you if you fail to redeposit the entire amount (including withheld taxes) within a 60-day window. Always choose a trustee-to-trustee transfer to avoid complications.
Missing the 60-Day Rollover Deadline
If you do an indirect rollover, meaning the money is sent to you before being redeposited into another retirement account, you have 60 days to complete the process. As per Investopedia, failing to meet the deadline results in your rollover becoming a taxable withdrawal.
Relying on limited IRS waivers for extenuating circumstances poses significant risks. To avoid the hassle, opt for a direct rollover whenever possible.
Rolling Over to an Account With Higher Fees
Not all retirement accounts are created equal. Some IRAs have higher fees, poor investment choices, or limited flexibility compared to your original 401(k).
To avoid expensive errors, compare management fees with fund choices and advisory costs before rolling over. Reduced fees allow you to maximize your investment returns by keeping more funds in the market.
Ignoring Employer Plan Benefits
Data by the U.S. Census Bureau notes that approximately 34.6% of working-age Americans (ages 15 to 64) have a 401(k)-style retirement account. Examine your current 401(k) plan’s benefits before moving your funds because certain advantages may not be available through a rollover IRA.
Certain retirement plans give participants access to low-cost institutional funds, creditor protection benefits, and special investment alternatives. A rollover may not suit your needs if your existing plan provides valuable benefits. Consult a financial advisor to evaluate your options before proceeding.
Failing to Consider a Roth Conversion
Rolling over your traditional 401(k) into an IRA allows you to convert some or all of your funds into a Roth IRA. Roth IRAs grow tax-free, but converting funds from other retirement plans demands immediate income tax payments.
If you’re in a lower tax bracket now than you expect to be in retirement, a strategic Roth conversion could save you a significant amount in future taxes, Kiplinger emphasizes. Since timing is essential, you should discuss this action with a tax professional.
Not Updating Beneficiaries
When rolling over retirement funds, many people forget to review and update their beneficiary designations. If your previous 401(k) plan designates an ex-spouse or old heirs and fails to list any beneficiary, your money may not go where you intended.
Naming primary and contingent beneficiaries ensures your funds are distributed according to your wishes. Updating now can help you avoid legal problems in the future.
Forgetting Required Minimum Distributions (RMDs)
When you reach 72 years old (or 73 years old starting from 2023, according to the SECURE 2.0 Act), rolling over your retirement funds will complicate your required minimum distributions.
Fidelity emphasizes that you must take RMDs every year, but if you don’t, you’ll face a 25% penalty for the amount missed. Check if any Required Minimum Distributions (RMDs) need to be withdrawn before proceeding with a rollover.
Rolling Over Company Stock Incorrectly
If your 401(k) includes employer stock, special tax rules called Net Unrealized Appreciation (NUA) may apply. You might face higher taxes in the future if you roll over company stock without considering specific tax regulations.
Under qualifying conditions, you should withdraw the stock because the capital gains taxes will be lower than ordinary income taxes. Work with a financial advisor to explore your best option.
Ignoring State Tax Consequences
State-specific regulations create various tax rules for rollovers and withdrawals. In some states, 401(k) distributions are exempt from taxation, while IRA withdrawals are taxable.
If you plan to move or retire in a different state, consider how your rollover decision affects your long-term tax liability. A financial planner will provide guidance through the unique tax regulations of each state.
Overlooking Spousal Rights in Certain States
If you’re married and live in a community property state, your spouse may need to sign off before you roll over funds from a 401(k). Some employer-sponsored plans need your spouse’s approval before any modifications take place.
Disregarding this requirement can lead to legal disputes and future complications. Ensure you understand all relevant rules and secure required approvals before you move funds.
Contributing Too Much After a Rollover
Keep in mind that when you transfer funds to an IRA, they remain subject to the same annual contribution limits. The limit for 2025 IRA contributions is $7,000, with an additional $1,000 available for those 50 years or older.
Contributing more than permitted to an IRA can result in tax penalties. The rollover process doesn’t register as an additional contribution, but all subsequent deposits are subject to annual contribution restrictions.
Overlooking Your New Investment Choices
Rolling over funds gives you control over your investments, but that also means you’re responsible for making smart choices. Some people roll funds over to cash accounts without investing them, due to this they lose potential market growth opportunities.
Others pick risky investments without a solid strategy. Dedicate time to selecting a diversified investment portfolio that matches your retirement objectives.
Forgetting to Rebalance Your Portfolio
After rolling over funds, your investment mix may no longer match your risk tolerance or retirement timeline. Market volatility has the potential to disrupt your existing asset distribution.
Rebalancing your portfolio regularly ensures you stay on track toward your financial goals. Schedule regular investment reviews annually and after significant market changes.
Not Seeking Professional Advice
Retirement rollovers can have major financial implications, and mistakes can be costly. A financial advisor or tax professional can help you choose the best option for your individual circumstances.
A professional advisor can guide you through tax decisions, investment possibilities and developing a long-term financial strategy. The expense of obtaining professional advice is usually much lower than you might pay due to errors during the rollover process.
Disclaimer – The Finance Key does not provide and does not intend to provide financial, investment, tax, or legal advice. Information contained in this article is for informational and educational purposes only. This list is solely the author’s opinion based on research and publicly available information. The inclusion of links to third-party content is not an endorsement by The Finance Key of such content or services. Please do your due diligence and use your discretion.
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