401k Mistakes to Avoid

You’re leaving your job and have questions about your 401k.

What should you do with your old 401k?

Despite what you may have heard, rolling your 401k over isn’t as easy as it sounds. You’ll want to be careful when you do so, if doing it by yourself, or even with a financial advisor. 

A 401k rollover refers to moving a 401k plan from a former or current employer into either an IRA or another qualified plan. If you have multiple 401ks or IRAs, you may wish to consolidate all your retirement accounts into a single IRA for simplicity.

Looks simple enough, right? So what could be the problem?

Here’s what could happen if you roll over your 401k incorrectly. If you’re under 59 ½ , you could be penalized with a 10% premature distribution. And, then you would have to pay taxes on the whole amount that you’ve withdrawn from the 401k. If you’re over 59 ½ , you would avoid the 10% penalty, but you would still have to pay the taxes on the whole amount of your 401k. Either way, you would essentially kill your 401k all together. This would defeat the whole purpose of setting up the 401k in the first place.

The whole idea with the 401k rollover is to transfer your old 401k funds to a new 401k (if your new employer permits) or to your very own IRA account without triggering a tax or penalty.

There are really only two ways to move company retirement plan money to an IRA: a direct trustee-to trustee transfer and a rollover. The preferred method is the direct trustee-to-trustee transfer.

Direct Trustee to Trustee Transfer Method

This is a direct transfer of funds from your old 401k to your IRA by way of your old company to the custodian that holds your IRA.

This method is highly recommended because you cannot trigger an unexpected tax or disqualify the transfer since you never touch the money. Trustee-to-trustee transfers are not subject to any tax withholding and are exempt from the one-per-year 60-day rollover rule.

Rollover Method

A rollover occurs when your company distributes your plan assets to you. You actually receive a check or stock certificates. Then it is up to you to transfer those assets to your IRA (or to another company’s plan) within 60 days after you receive the distribution from your plan.

If you miss the 60-day deadline, you’re out of luck. You must report the entire distribution as income. You’ll pay income tax on the entire distribution and, if you have not yet reached age 59-1/2, you will also pay a 10 percent penalty on the distribution.

You can do only one 60-day rollover per year, but the year is actually any 12-month period and not necessarily a calendar year. The one per year 60-day rollover rule applies separately to each IRA you own.
 

Avoid Rollover Nightmares

If you choose the rollover method to move your company pension money to your IRA, you may be subject to mandatory 20 percent withholding tax. This means that you will receive only 80 percent of your pension money and the rest will be sent to Uncle Sam to pay any tax owed on the transfer.

The problem is that you should not owe any tax. But now, because of the 20 percent withholding tax rule, you’ll have only 80 percent of your company retirement money to roll to your IRA. If you roll over only 80 percent, then you’ll pay tax and be subject to the 10 percent penalty on the 20 percent that was not rolled over. The only way out of this predicament is to have other, non-pension or non-IRA funds available to make up the 20 percent shortage. If you don’t, you’ll be stuck paying tax and a possible 10 percent penalty on the 20 percent that was not rolled over.

Why Should You Rollover or Transfer Your 401k?

A number of reasons:

1.       Simplicity.  By rolling your 401k, you could consolidate it with your other IRA accounts into one single IRA. That way it’ll be easier to manage.

2.      Avoid High Fees: You may be able to avoid the high internal expenses with your 401k. While some 401k plans don’t carry high fees, some do. And, it’s best to avoid having to pay these fees when you don’t have to. It is not easy to find out what it cost you to have your money in a 401(k) or similar employer sponsored retirement plan. When the funds are left with the plan sponsor, they may not be invested as you desire and there is an additional layer of administration to go through for the former plan participant. Your plan fees may be higher than your Rollover IRA fees. By rolling over your retirement funds you stay in control of these costs by choosing who administers and manages your funds.

3.      More Choices:  You can decide on how you want to invest your IRA.   You’re not bound by the funds or stock choices inside of your 401k. You could invest your IRA anyway you choose such as with real estate, mutual funds, stocks, bonds, annuities, etc. Some companies have large portions of their employees’ profit sharing and 401(k) funds in their company stock. By taking your pension funds with you, you have more control on how your money is invested and your level of diversification.

4.      Convert into a Roth IRA:  The only way to convert your 401k into a Roth IRA is via rolling it over to an IRA first. 

5.  Distressed companies may spell trouble.  Large and small companies fall on hard times. When they do, your pension funds may be in jeopardy. There have been cases where employees have lost money because they can’t get their pension funds due to a bankrupt or corrupt former employer. However, once your funds are rolled over, you won’t have to be concerned about what happens to your former employer.

6.  Your previous employer may get bought out or merge with another company.
The rules governing your retirement plan are largely decided by your employer. These rules may very well change when a company is merged or sold. And who knows, these changes may work to your disadvantage. By rolling your funds over now, you won’t have to be concerned about what happens to your former employer.

7.  Eliminate Spousal control of beneficiaries.  If your retirement funds are left in a retirement plan, the consent of your spouse will be needed if you decide to name anyone other than your spouse as the beneficiary. You, on the other hand, may want someone else to receive that money.

8.  Control the access to your funds.  Some plans do not allow a participant to withdraw only a portion of their funds. Also loans from the plan may no longer be available to you after you leave your employer.  

9.  Reduce the tax burden for your Beneficiaries.    Upon your death, your spouse has the option to withdraw your pensions funds and roll them over to a tax-deferred IRA rollover account. Any other beneficiary would be required to pay taxes on any payout of your pension funds .

Some beneficiaries may not need these funds right away and would rather delay receiving a payout in order to avoid the income taxes and to take advantage of the continued tax-free buildup inside the plan. Your beneficiary may be stuck if the plan forces them to take the account balance. 

We can help you rollover your 401k, 403b, TSA, IRA or other Qualified Accounts. Click here for a complimentary consultation, or call us (810) 714-9021. Don’t make the mistake of incorrectly rolling over your 401k, it could cost you hundreds, if not thousands!