“Opportunity is missed by most people because it is dressed in overalls and looks like work.”
~ Thomas Edison
Life is full of change. It is no surprise we are often faced with changes in employment. Regardless of what led to the change, you’re left with questions about your employer sponsored retirement plan, likely a 401(k). Here is a list of the top mistakes people make when rolling a 401(k), and how to avoid them.
The Number One Mistake: Taking a check. Your former employer is likely to explain you have three options. Leave the money, receive a check for a lump sum, or roll over the funds to a new 401(k) or Individual Retirement Account (IRA). The worst decision is to take a check - known as a rollover. The biggest risk is yourself - you may be tempted to spend the funds. Also by law, your employer must withhold 20% in taxes before you see a penny. Further, by agreeing to take a direct lump sum, you also start a 60 day clock. You have 60 days to reinvest these funds in a qualified account such as an IRA. If you miss this 60 day window, you will have to pay income taxes on the entire distribution, and if you are under 59 ½ you will also face a 10% tax penalty on the entire amount.
How to avoid it. It is tempting to take a check, especially if you are looking for employment and want to dip into your savings as a back-up plan. Don’t. It will wreck financial havoc on your retirement plans.You will thank yourself later. Do some research, or consult a trusted financial advisor to decide on an IRA custodian to receive the funds. Next, contact your former 401(k) administrator and request forms to complete a “Direct Rollover”. This ensures the funds are made payable to, and go directly to the new IRA custodian allowing you to avoid the 20% withholding, the 60 day clock and the 10% IRS penalty. Most importantly, you ensure you save your retirement savings for when you retire.
The Second Big Mistake: Choosing a rollover instead of a Direct Rollover (or transfer if applicable). The key to avoiding this mistake is simply understanding the definitions. A rollover is a distribution from a retirement plan that is paid directly to you and then you have to contribute those funds into another qualified retirement plan. Rollovers come with the rigid 60 day timeline, and a mandatory 20% withholding. A Direct Rollover, the method we recommend, results in a transfer made payable directly to the qualified plan or IRA custodian, never to the individual. A transfer occurs when an individual moves IRA funds from one custodian directly to another custodian (i.e. no 401(k) involved). A transfer is non-reportable, and can be done an unlimited number of times during a period.
How to avoid it. Don’t try to be the middleman. Elect a Direct Rollover from your 401(k) to an IRA. If you don’t receive the funds, you will avoid the rules and penalties associated with a rollover.
Another Big Mistake: Rushing through important decisions. Your retirement is likely the biggest asset you will ever have. You work hard to save for your future. No one else is going to make sure you protect these funds. Two pointers. First, make sure your asset allocation aligns with your risk tolerance. Second, don’t put off naming primary and contingent beneficiaries. There is no better time than the present. Use this time to evaluate your long term strategy and retirement goals.
How to avoid it. Slow down, make sure you are informed, and get advice if it is needed. These are big decisions. Most mistakes are not reversible and can cost you years on your retirement.
Here is a list of scenarios where you will most likely need the assistance of a trusted financial advisor;
- You aren’t sure where to move the funds.
- You don’t know where you stand on your retirement strategy, or simply want to feel confident in your decision.
- Your 401(k) includes appreciated employer stock. There are net unrealized appreciation rules that need to be considered.
- You are considering a Roth conversion.
- You have an inherited IRA.