Rolling over your 401(k) to an Individual Retirement Account (IRA) can be a wise move, offering greater control over your investments and potentially more diverse investment options. However, this process can be fraught with pitfalls that can impact your retirement savings.
As a fiduciary, Advance Capital Management is committed to recommending only what’s in your best interest. When helping clients with retirement planning, our goal is to make any necessary move as efficient as possible.
In addition to taking the right steps, avoiding common mistakes is crucial to ensure your financial future remains on track. Here are some key 401(k) rollover mistakes to avoid.
What is a 401(k) rollover and how does it work?
A 401(k) rollover is the process of transferring the funds from your 401(k) retirement account into another retirement account, typically an Individual Retirement Account (IRA). This can happen when you change jobs or retire, often as a way to consolidate your retirement savings into a single account.
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Not understanding the types of rollovers
There are two primary ways to roll over your 401(k): direct and indirect rollovers.
A direct rollover is the safest option where the funds are transferred directly from your 401(k) to your IRA.
In an indirect rollover, you receive the funds from your 401(k) and have 60 days to deposit them into an IRA. If you miss this deadline, the IRS considers it a distribution, subjecting it to taxes and potential penalties.
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Leaving rolled-over funds in cash
One of the most significant mistakes investors make is leaving their rolled-over funds in cash. While having some cash in your portfolio for emergencies or short-term needs is prudent, leaving a large sum in cash can be detrimental to your long-term growth.
According to a Vanguard report, about 28% of savers who rolled over 401(k) funds into an IRA in 2015 didn’t reinvest the money, leaving it sitting as cash for at least seven years. This is a mistake that costs savers a collective $172 billion per year, or $130,000 per person, in forgone wealth by the time they reach retirement age.
Cash typically earns minimal interest. Over time, inflation can erode the purchasing power of your cash holdings. By not investing your funds, you miss out on potential growth opportunities that the stock and bond markets offer.
To avoid this, develop a diversified investment strategy that aligns with your risk tolerance and retirement goals.
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Forgetting to update beneficiary designations
When rolling over your 401(k) to an IRA, it’s essential to update your beneficiary designations. Many people assume that their beneficiary designations automatically transfer, but this is not the case.
Ensure your loved ones are properly designated on the new account to avoid any legal complications or disputes later.
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Failing to consider fees
Fees can significantly erode your retirement savings over time. When rolling over your 401(k) to an IRA, pay attention to the fees associated with your new account. Look out for annual account fees, trading fees and mutual fund expense ratios.
Comparing these costs with those of your 401(k) plan can help you make a more informed decision.
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Missing out on employer stock perks
If your 401(k) includes company stock, special tax treatment might apply if you roll it over to an IRA. This is known as Net Unrealized Appreciation (NUA). If you take advantage of NUA, only the cost basis of the stock is taxed as ordinary income, and the growth is taxed at the lower long-term capital gains rate.
Missing this could result in higher tax liabilities, so consult a financial adviser to understand if this applies to you.
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Not considering Roth conversions
Rolling over your 401(k) into a traditional IRA means that your funds will continue to grow tax-deferred. However, you might want to consider converting some or all of your traditional IRA to a Roth IRA.
While this will trigger a tax event on the converted amount, future withdrawals from a Roth IRA are tax-free, provided certain conditions are met. This can be particularly beneficial if you expect to be in a higher tax bracket during retirement.
Consulting a financial or tax advisor can help determine if this strategy makes sense for you.
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Not seeking professional guidance
As all the mistakes above make clear, the process of rolling over a 401(k) can be complex, with many rules and potential tax implications. But a financial adviser can help you navigate the rollover process, choose the right investments and develop a strategy that aligns with your retirement goals.
You can even hire a financial adviser to help manage your 401(k). For instance, our ACM 401(k) Builder service includes full-service financial planning, where your adviser will provide advice and guidance for every aspect of your financial journey – from buying a house to paying your child’s college tuition.
Bottom line
Rolling over your 401(k) to an IRA can be a beneficial move, but it requires careful planning and attention to detail. By avoiding these common 401(k) rollover mistakes, you can allow your retirement savings to continue to grow and work for you.
Remember, when in doubt, seek professional guidance to make the best decisions for your specific situation.
If you’re worried about what to do with your 401(k), why not schedule a free consultation with an Advance Capital Management financial adviser today?
Advance Capital Management is a fee-only RIA serving clients across the country. The Advance Capital Team includes financial advisers, investment managers, client service professionals and more — all dedicated to helping people pursue their financial goals.
