5 Rollover Mistakes to Avoid
Rolling over a 401(k) can be an arduous and confusing process made worse by the fear of making an error that has unintended consequences. And while there are companies out there like Capitalize who can help you with a rollover, knowing a few key mistakes to avoid will give you more confidence in the rollover process.
Mixing pre-tax and post-tax money
When it comes to rolling over retirement accounts, it’s important to know what type of money you have in the account: pre-tax or post-tax.
Pre-tax (Traditional): The money you contribute to your retirement account is not taxed when it is deposited, but it is taxed when you withdraw it.
Post-tax (Roth): You pay taxes on your income before you contribute it to your account so you don’t pay taxes on it upon withdrawal.
When you do a rollover, you want to match the type of account that you are rolling over from and to the type of account that you are rolling over to. For example, a traditional 401(k) must be rolled over into a traditional IRA, and a Roth 401(k) must be rolled over into a Roth IRA. It’s possible that you have both a traditional 401(k) and a Roth 401(k) with the same provider which means you’ll need to roll over those balances into separate IRAs!
Indirect rollover puts you on the hook for extra cash
There are three different rollover processes and the one you choose could affect your bank account or taxes:
Indirect Rollover: With an indirect rollover, your old 401(k) provider will send you a check made out in your name. The provider must withhold 20% of your balance for taxes in this case because you could just cash the check and the government wants to make sure it gets its cut!
Direct Rollover: With a direct rollover, your 401(k) provider will send you a check in the name of your new provider “for the benefit of” (FBO) you. Because the check is made out to the provider, the check will be for the full balance of your account.
Trustee-to-Trustee Transfer (or Direct Transfer): With this method, the two providers cut out the middle man (AKA you). Your old provider will send the balance of your account directly to your new provider.
The indirect rollover creates a problem: you received a check for 80% of your account balance. To avoid having the remaining 20% of your balance taxed and penalized as an early withdrawal, you must replace the difference from your own pocket! While you will get that money back at tax time, it could leave you in a cash crunch in the short term depending on the size of your account.
Waiting too long to deposit a check
There is another pitfall of the indirect rollover lurking in the corner: if you don’t deposit your check into another 401k or IRA within 60 days of receiving the check, the full balance will be considered a withdrawal. This means you’ll have to pay taxes and the 10% penalty on the balance. This is the reason that you may also hear an indirect rollover called a “60-day” rollover.
More than one indirect rollover in 12 months
You are only allowed to do an indirect rollover between IRAs once every 12 months. This does not apply to rollovers between IRAs and 401(k)s or between a traditional IRA and a Roth IRA.
The distribution date is actually what counts here (not when the money was deposited into the new account). The rule applies across all of your IRAs meaning that if you have three IRAs and want to combine them into one IRA, you must do a direct rollover/transfer or space them out every twelve months.
Not investing your money
Once you’ve finally succeeded in getting your money into your new account, you still might not be done! If you rolled over your 401(k) into an account with a traditional brokerage like Vanguard, Charles Schwab, Fidelity, or E-Trade, your account balance will be sitting in cash which means that it will not be growing for you the way that retirement money is intended to! To fix this, you’ll need to invest the money. If you aren’t sure about the nuts and bolts of investing your balance, call your provider’s customer service and ask them to walk you through it.
Need guidance about a rollover?
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