I’m a Financial Advisor: Avoid These 7 Mistakes When Rolling Over Money Between Retirement Accounts
Written by
Laura Beck
Edited by
Jairo Rodriguez
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One of the most important financial decisions you’ll make is how to handle your retirement accounts when changing jobs. Rolling over your 401(k) or other accounts correctly can ensure your hard-earned retirement savings keep growing tax-deferred. But making mistakes during this process can cost you big time in taxes, penalties and lost future growth.
Here are six potentially costly mistakes to avoid when rolling over retirement money, according to financial advisors.
Having the Rollover Check Made Payable to You
“Rolling over your 401(k) to an IRA or another 401(k) is usually done by check. Do not have the check made out to yourself!” said Jake Skelhorn, CFP and former Merrill Lynch advisor now at Spark Wealth Advisors. “This is taxable and will be subject to a mandatory 20% withholding. The rollover check needs to be made payable to the gaining institution, or sometimes the name of your employer if it’s a 401(k).”
Not Paying Off 401(k) Loans First
“Pay off any loans prior to rolling over,” Skelhorn shared. “Most of the time, processing a rollover closes your old 401(k), which will cause you to default on any outstanding loan balances. The loan will be reclassified as a withdrawal and subject to taxes and possibly penalties. If you can, pay off the loan first to not only avoid taxes but put more money back into the tax-deferred account where it can continue compounding.”
Using a 60-Day Indirect Rollover
“Using a 60-day rollover, also called an indirect rollover, is a huge mistake,” said Stephen Kates, CFP and principal financial analyst for Annuity.org. “All rollovers should be set up to transfer in what is called a ‘trustee-to-trustee transfer’ process instead.”
With a trustee-to-trustee transfer, the money moves directly between financial institutions without you taking possession of it. This avoids the 60-day time limit, mandatory 20% tax withholding and risk of forgetting to redeposit funds before the deadline.
“A trustee-to-trustee transfer means that the money will move directly between the financial institutions and will not be received or handled by the person who owns the account,” Kates said. “This is a cleaner and safer way to transfer the money and will limit any mistakes.”
Not Separating Pre-Tax and Post-Tax Funds
“It is important to understand the tax status of your retirement money especially if you have a mixture of pre- and post-tax contributions in your retirement account,” Kates said. “When making transfers, investors will need to direct pre- and post-tax money to separate accounts to make sure they are not either commingled incorrectly or mailed out as a retirement distribution.”
Being Unprepared With Transfer Details
Before initiating a rollover, you’ll need to have these key details about the receiving account:
- Name of the receiving institution
- Address of the receiving institution
- Account number at the receiving institution
- Type of account (IRA, 401(k), etc.) to receive the funds
“Prepare the necessary information before you start your transfer,” Kates said. “Most institutions need [these] four pieces of information to complete a transfer.”
Triggering Taxes and Potential Penalties
Beyond the mandatory 20% withholding if you receive funds directly, early withdrawals from tax-deferred retirement accounts before age 59 ½ are subject to regular income taxes plus a 10% penalty in most cases. This can seriously erode your retirement savings.
A rollover that’s handled properly as a trustee-to-trustee transfer avoids taxes and penalties since the money never leaves the tax-deferred retirement account environment.
Wondering about 401k withdrawal options? Check out our expert guide for insights on withdrawals, taxes and more.
Not Taking a Comprehensive Wealth Management Approach
“The simplest and best method of maximizing retirement accounts comes from quality communication between both tax professionals and financial professionals in unison for a client’s behalf,” said Ryan Moore, financial advisor at TBS Retirement Planning. “Take that communication a step further and bring in the estate attorney, and then you have the full spectrum of wealth being viewed cohesively.”
Moore stresses the importance of having an integrated wealth management strategy that coordinates retirement account rollovers with overall tax planning and estate planning goals.
“A missed opportunity when it comes to transferring retirement accounts is not maximizing the current tax return and calculating the costs of possible Roth conversions each year,” he said. “If it is achievable to make money grow tax-free into the future, then most of the time the upfront conversion cost is small in comparison to the lifelong benefit gained in the process, as well as the generational benefits gained when transferring money to heirs.”
The bottom line is that while rollovers seem simple on the surface, there are many potential pitfalls that can cost you a substantial portion of your retirement savings in avoidable taxes and penalties. Following the above advice from financial advisors can help ensure your rollover is completed accurately and without any unnecessary fees or taxes eating away at your future retirement income.
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