Financial Planning
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Mistakes when rolling over your old 401(k) can be expensive and annoying. Sadly, these 401(k) rollover mistakes are also surprisingly common. On a happier note, they are easy to avoid.
First, not all 401(k) assets can or should be rolled into an IRA. Ignoring this can cause expensive tax problems or lead you to miss some tax-minimizing and financial planning opportunities. A failed rollover may cause the entire balance to be distributed, which could make the withdrawal fully taxable. You may also get hit with a 10% early withdrawal penalty, depending on your age. NO FUN!
Here are 6 examples of 401(k) mistakes that everyone reading this will want to avoid.
It's not how much you contribute to your 401(k) but how much you leave to grow in your 401(k). If you continuously pull money from your 401(k) or cash it out every time you switch jobs, you will find it hard to stay on track for financial freedom.
I know when times get tough, it may be tempting to liquidate your retirement accounts to pay bills. Doing so could have terrible repercussions for your future retirement security. Also, you will get hit with excessive taxes and early withdrawal penalties.
You’d be shocked by how many people have lost track of an old retirement account. In 2015 alone, Americans lost track of more than $7.7 billion worth of retirement savings by "accidentally and unknowingly" abandoning their 401(k)s.
You are busy and probably switched jobs and addresses a few times over the years. It's easy to see how you could forget where your old 401(k) is held. Perhaps your former employer was sold; maybe you moved and forgot to update your address with the 401(k)-plan administrator. For these reasons, I'm a fan of consolidating old retirement accounts, if for no other reason than to make your life easier and the account easier to track.
I hate when I see people attempting to roll over their IRAs or 401(k)s, with low-fee investment options, into annuities with a crazy array of hidden fees. Often with the help of an annuity salesperson, holding themselves out as a financial advisor. Sadly, the huge upfront commissions annuities can bring financial salespeople are too hard to resist. And you, the consumer, may get stuck paying exorbitant fees to cover these commissions.
Not all annuities are bad, but make sure you buy for the right reasons. Whenever possible, work with a fiduciary financial planner so you know they aren't recommending an annuity to get a hefty commission or keep their employer-based health insurance. (Some salespeople must sell a certain amount of their company's products to get their health insurance paid for by their employer.)
Regardless of where you are in the calendar year, required minimum distributions (RMD) can never be rolled over. It is common for people to make this 401(k)-rollover mistake. In the event an RMD is rolled over, it will become an excess IRA contribution subject to the 6% penalty unless it is removed by October 15 of the year following the year of the excess contribution. Usually, you will find out you made this mistake when you receive a wonderful tax notice from the IRS, and nobody wants to receive that.
5. Improperly Rolling Over After-Tax Funds
Don't feel bad if you have no idea what I'm talking about here. But if you think you might have some after-tax funds in your 401(k), pay close attention.
If you have after-tax IRA funds in your 401(k), they cannot be rolled over to a new company plan. Only pre-tax IRA funds can be rolled over. This rule is to your advantage because it allows you to isolate the cost basis of the after-tax funds in the IRA. Typically, you can roll this portion of the 401(k) over to a Roth IRA.
Once after-tax funds have been moved to a Roth IRA, they can grow tax-free and eventually be withdrawn tax-free.
There are risks to taking a 401(k) loan. It is a debt that will need to be repaid at some point. If it isn’t paid, you can end up with a significant tax bill.
When you leave your employer, your payments toward the 401(k) from your paycheck will stop. Eventually, your remaining 401(k) loan balance will be deemed a distribution. A deemed 401(k) distribution is taxable and may also be subject to the 10% early distribution penalty (for those not yet 59.5 years of age). The deemed distribution amount, or loan balance, is not eligible to be rolled over to an IRA, even if the employee has the funds to complete the rollover.
A trusted fiduciary financial planner can help you make the wisest choices with your retirement funds. Remember that they may not always be able to clean up the mess after a big 401(k) rollover mistake has been made.
6 Expensive Mistakes To Avoid With Your 401(k) Rollover
First, not all 401(k) assets can or should be rolled into an IRA. Ignoring this can cause expensive tax problems or lead you to miss some tax-minimizing and financial planning opportunities. A failed rollover may cause the entire balance to be distributed, which could make the withdrawal fully taxable. You may also get hit with a 10% early withdrawal penalty, depending on your age. NO FUN!
Here are 6 examples of 401(k) mistakes that everyone reading this will want to avoid.
1. Raiding Your 401(k) Instead of Rolling It Over
It's not how much you contribute to your 401(k) but how much you leave to grow in your 401(k). If you continuously pull money from your 401(k) or cash it out every time you switch jobs, you will find it hard to stay on track for financial freedom.
I know when times get tough, it may be tempting to liquidate your retirement accounts to pay bills. Doing so could have terrible repercussions for your future retirement security. Also, you will get hit with excessive taxes and early withdrawal penalties.
2. Losing Track Of Your Old 401(k)s
You’d be shocked by how many people have lost track of an old retirement account. In 2015 alone, Americans lost track of more than $7.7 billion worth of retirement savings by "accidentally and unknowingly" abandoning their 401(k)s.
You are busy and probably switched jobs and addresses a few times over the years. It's easy to see how you could forget where your old 401(k) is held. Perhaps your former employer was sold; maybe you moved and forgot to update your address with the 401(k)-plan administrator. For these reasons, I'm a fan of consolidating old retirement accounts, if for no other reason than to make your life easier and the account easier to track.
3. Rolling Over Your 401(k) to A High-Fee Annuity
I hate when I see people attempting to roll over their IRAs or 401(k)s, with low-fee investment options, into annuities with a crazy array of hidden fees. Often with the help of an annuity salesperson, holding themselves out as a financial advisor. Sadly, the huge upfront commissions annuities can bring financial salespeople are too hard to resist. And you, the consumer, may get stuck paying exorbitant fees to cover these commissions.
Not all annuities are bad, but make sure you buy for the right reasons. Whenever possible, work with a fiduciary financial planner so you know they aren't recommending an annuity to get a hefty commission or keep their employer-based health insurance. (Some salespeople must sell a certain amount of their company's products to get their health insurance paid for by their employer.)
4. Required Minimum Distributions and 401(k) Rollovers
Regardless of where you are in the calendar year, required minimum distributions (RMD) can never be rolled over. It is common for people to make this 401(k)-rollover mistake. In the event an RMD is rolled over, it will become an excess IRA contribution subject to the 6% penalty unless it is removed by October 15 of the year following the year of the excess contribution. Usually, you will find out you made this mistake when you receive a wonderful tax notice from the IRS, and nobody wants to receive that.
5. Improperly Rolling Over After-Tax Funds
Don't feel bad if you have no idea what I'm talking about here. But if you think you might have some after-tax funds in your 401(k), pay close attention.If you have after-tax IRA funds in your 401(k), they cannot be rolled over to a new company plan. Only pre-tax IRA funds can be rolled over. This rule is to your advantage because it allows you to isolate the cost basis of the after-tax funds in the IRA. Typically, you can roll this portion of the 401(k) over to a Roth IRA.
Once after-tax funds have been moved to a Roth IRA, they can grow tax-free and eventually be withdrawn tax-free.
6. Plan Loans — Deemed 401(k) Distributions
There are risks to taking a 401(k) loan. It is a debt that will need to be repaid at some point. If it isn’t paid, you can end up with a significant tax bill.
When you leave your employer, your payments toward the 401(k) from your paycheck will stop. Eventually, your remaining 401(k) loan balance will be deemed a distribution. A deemed 401(k) distribution is taxable and may also be subject to the 10% early distribution penalty (for those not yet 59.5 years of age). The deemed distribution amount, or loan balance, is not eligible to be rolled over to an IRA, even if the employee has the funds to complete the rollover.
A trusted fiduciary financial planner can help you make the wisest choices with your retirement funds. Remember that they may not always be able to clean up the mess after a big 401(k) rollover mistake has been made.
