4 Common 401(k) Rollover Mistakes
25 Sep 2024
Deciding what to do with your 401(k) when changing jobs or retiring is an important step in managing your retirement savings. Rolling your 401(k) to an IRA is a popular option for many investors. In fact, according to data from the IRS, in 202o, about 5.7 million people rolled a total of $618 billion to IRAs. However, this process can come with potential pitfalls that can cost you in the long run. In this article, we’ll explore common blind spots and mistakes individuals make during a 401(k) rollover.
Mistake #1: Not Investing Your Assets Once They Are in Your IRA
One of the most significant mistakes people make after rolling over their 401(k) is not investing their assets in the new IRA account. This issue, often referred to as “cash drag,” can significantly hinder your retirement savings growth. According to a Vanguard study, about two-thirds of investors left their rollover assets in cash, up to a year either due to lack of awareness (68%) or procrastination (15%). The study found that two-thirds of investors who remained in cash did so unintentionally, believing their assets were automatically invested.
The impact of cash drag is substantial. While your money sits in a money market fund or a cash equivalent, it is not working to its full potential. Over time, this can lead to a significant shortfall in your retirement savings, as you miss out on the compounded growth that investments in equities, bonds, or mutual funds could provide.
Why Does This Happen?
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Lack of Awareness: Many investors mistakenly believe that their IRA operates similarly to their 401(k), where contributions are often automatically allocated to specific funds, such as target-date funds. In reality, IRA contributions require active selection of investments, and the default is often a money market fund, which yields minimal returns.
- Procrastination: Some individuals delay investing because they feel overwhelmed by the plethora of investment options available in an IRA. Unlike 401(k) plans, which typically offer a limited set of curated funds, IRAs present thousands of choices, including stocks, bonds, and mutual funds. This abundance of choice can lead to analysis paralysis, resulting in the investor leaving their assets in cash indefinitely.
Mistake #2: Forgetting About An Old 401(k)
With the average American changing jobs every four years, it’s easy for old 401(k) accounts to be forgotten. Each job change potentially adds another 401(k) to the mix, it becomes challenging to keep track of multiple retirement accounts, increasing the risk of losing sight of your overall asset allocation and retirement goals.
Mistake #3: Cashing Out Early
Cashing out your 401(k) early can be tempting, especially if you’re facing financial challenges. However, this decision comes with severe penalties and taxes. If you’re under 59 ½, you’ll face a 10% early withdrawal penalty in addition to paying federal and state income taxes on the amount withdrawn. This can easily erode a substantial portion of your savings.
Mistake #4: Rolling Over to a New Employer’s 401(k) Without Considering Fees and Options
While rolling over to a new employer’s 401(k) may seem like a straightforward solution, it’s essential to evaluate the new plan’s fees and investment options. Some plans may have limited choices or higher administrative fees compared to an IRA. It’s crucial to compare these factors before deciding to consolidate your accounts into the new 401(k).
Best Practices for a 401(k) Rollover
- Review Your Options: Consider all available options—leave your 401(k) with your former employer, roll it over to a new 401(k), or transfer it to an IRA. Analyze the fees and investment options associated with each choice.
- Invest Promptly: Once you’ve rolled over your assets into an IRA, invest them in a diversified portfolio that aligns with your retirement goals and risk tolerance. Don’t let the fear of making a wrong decision keep you from making any decision at all.
- Seek Professional Guidance: If you feel overwhelmed by the choices, consider consulting a financial advisor who can help you navigate the rollover process and make informed investment decisions.
Rolling over a 401(k) is an important step in managing your retirement savings, but it’s crucial to be aware of these common blind spots. By avoiding these mistakes, you can help your retirement savings grow and support your financial goals.
Important Information:
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Securities and advisory services offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
All investing involves risk including the possible loss of principal. No strategy assures success or protects against loss.
A plan participant leaving an employer typically has four options (and may engage in a combination of these options), each choice offering advantages and disadvantages.
• Leave the money in his/her former employer’s plan, if permitted;
• Roll over the assets to his/her new employer’s plan, if one is available and rollovers are permitted;
• Roll over to an IRA; or
• Cash out the account value.
Vanguard Study: Out of sight, out of market: The IRA cash drag, Vanguard – September 5, 2024
