The 4 Biggest 401(k) Rollover Mistakes

 By Cyril S. White, Certified Financial Planner™

 

As people transition from one employer to another, many are still uncertain about what to do with their 401(k) plan when they leave their employer. Here are 4 of the biggest mistakes you should avoid when considering what to do with your 401(k).

 

A plan participant leaving an employer typically has four options (and may engage in a combination of these options as well), each choice offering advantages and disadvantages.

 

1.     Leave the money in his/her former employer’s plan, if permitted;

2.     Roll over the assets to his/her new employer’s plan, if one is available and rollovers are permitted;

3.     Roll over to an Individual Retirement Account (IRA); or

4.     Cash out the account value. 

Each of these options can have a significant impact on your financial goals if not planned and implemented correctly. 

 

We have found that there are four major mistakes people make with regard to their employer sponsored retirement plan after they have separated from employment from them. 

 

Each of these common mistakes are discussed in this edition of my newsletter below.

Mistake #1: MAKING THE CHECK OUT TO YOURSELF

 

This a bad idea altogether and truly defeats the purpose of having dollars earmarked for retirement. If you are under 59 1/2 years of age, you will pay a 10% early distribution penalty (source IRS.gov). In addition, the distribution will be treated as ordinary income in the tax year that you take the distribution. This could potentially cost you up to 30 or 40% of your balance based upon your personal income tax brackets. Lastly, the government withholds 20% of your check when you have your distribution check made payable to yourself which will make your net check from the 401(k) even lower. While you may be eligible to receive some of this back when you file your taxes, consider what the after tax check amount will be no matter how small or large your balance is within the 401(k) plan.

Mistake #2: DOING NOTHING.

Many people are unaware of how a direct transfer of your 401(k) plan to a rollover IRA actually works.  Since it can be a very intimidating process, many people just choose the path of least resistance and leave the money at their old place of employment. Most 401(k)s have limited investment choices. With a rollover IRA account there can be many more investment choices to select from. If the paperwork is completed correctly, a 401(k) to rollover IRA transfer can be one of the easiest things to get done in your personal financial plan to gain control of your retirement.

Mistake #3: NET UNREALIZED APPRECIATION

 

If you work for a company where you are buying company stock within your retirement plan, when you leave your employer, there is a crucial tax management decision regarding what you should do with the company stock. You have the opportunity to pay ordinary income tax on your cost basis of the company stock, and pay capital gains tax on the growth if the election is done successfully. However, once you rollover your 401(k) to an IRA, this election will no longer be available. People who have worked for a long period of time for one employer where they have a sizable amount of company stock do not often realize the implication of missing out on Net Unrealized Appreciation option. Please consult your tax advisor or go to www.irs.gov to learn more about this option.

Mistake #4: LEAVE IN “SET IT AND FORGET IT” STRATEGY

 

One of the most popular products used in 401(k) plans are the Target or Lifecycle Retirement funds. These funds typically have names such as “Target 2035” in your 401(k) plan. The idea of these funds is that the fund company will do the work and adjust the asset allocation (e.g., how much you have invested in stocks, fixed income and cash) balances until you retire in in the year designated by the fund name (i.e., 2035 in our example).  Theoretically, the fund is supposed to become less risky the closer you get to your “target date” Not all

these funds are created equal and nothing is guaranteed.  Therefore, you want to make sure that your 401(k) portfolio asset allocation is in fact working as advertised and taking the amount of risk you are comfortable with.

 

 

The 401(k) plan is typically the most important component of most people’s retirement plans.  Knowing how to avoid these four common mistakes can mean the difference between having to work longer or retiring when you want to.

If you have any questions or if there is anything else I can do for you please contact me at cyri.white@fourfinancial.com or (734) 272-4322

The information provided in these materials is for general information only and are not intended to provide specific advice, recommendations for any individual and does not constitute any legal, tax or accounting advice. Please consult with a qualified professional for this type of advice. Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Four Financial Management, a registered investment advisor and separate entity from LPL Financial. Not FDIC Insured, May Lose Value, No Bank Guarantee