New job, new you. (Heck yeah.) But also ... old job, old 401(k). So what should you do with it?
One option is a 401(k) rollover, which means transferring your investments from your old account to a new retirement account — typically an IRA or your new employer’s 401(k). (Check out our 401(k) rollover explainer for all the deets.)
But because 401(k)s and IRAs come with tax benefits, they also come with rules and deadlines. And those can really cost you. So if you’re thinking about rolling over your account, here’s a handy list of common mistakes we see at Ellevest — and how to avoid them.
1. Not doing it at all
There are a few reasons why simply leaving your old 401(k) where it is might not be your best bet. First of all, you won’t be able to contribute to it anymore, so it’s easier to accidentally lose track of it. And knowing exactly how much money you have invested (and where) is a big part of establishing control over your financial life.
But second — and maybe more important — rolling over your old 401(k) (especially into an IRA) could give you more investment options. Yes, that old 401(k) probably gives you a set of different investments to pick from … but you’re limited to just that set. An IRA can usually give you more freedom to invest in your values or choose less expensive securities.
Plus, if you decide to roll your 401(k) over to somewhere new, you can shop around for a company that charges less in administrative fees than your old 401(k) provider does. That can have a big impact on your bottom line. And keep in mind that if your old employer was helping out with the cost of those fees while you worked for them, it’s reasonable to assume that they’ll stop now.
(There are some situations where leaving your 401(k) where it is might make sense, like if your old 401(k) has abnormally low fees or unique investment options. Crunch the numbers before deciding to move your money.)
2. Missing the 60-day deadline
So, the #1 thing you almost always don’t want to do with an old 401(k) is just cash it out. That comes with massive tax penalties that could cost you up to 50% of the value of your account. (Ouch.)
If you take the money out of your old 401(k), you can’t sleep on the process. You have only 60 days to get it deposited into a new retirement account — otherwise, the IRS will assume you cashed out and hit you with those taxes. (Although there is a short list of reasons they might forgive you — life happens, after all.)
Also good to know: If your old 401(k) had less than $1,000 in it when you left your job, your employer might just send you a check. If that happens, open a new IRA or 401(k) ASAP so you can invest it before the 60 days are up.
3. Making the check out for the wrong amount
When it comes to rollovers, there are two main types: direct rollovers and indirect rollovers. With a direct rollover, your old 401(k) administrator writes a check to your new administrator, so the funds go directly to them.
With an indirect rollover, on the other hand, you take on the burden of passing the money along. Your old 401(k) administrator will write a check to you, and then you’ll deposit that money in your bank account so you can write a check to your new account administrator (all within 60 days).
And there’s a potential snag here: The check from your old 401(k) is going to be short 20% of the balance in your account. That money gets withheld to essentially “pre-pay” your taxes in case you miss the 60-day deadline. But the check you write to your new account administrator has to be for the full amount of the rollover. So that means you have to come up with the cash to cover that 20%. (If you deposit the money into a new retirement account before the 60-day deadline, you’ll get your 20% back at tax time.)
So if you use an indirect rollover, be super careful with this step. In fact, we recommend doing everything you can to avoid the indirect route — direct rollovers leave a lot less room for error. Plus, the IRS limits you to one indirect rollover a year, but there’s no limit on direct rollovers.
4. Not telling your new investment company first
Whether you use a direct or an indirect rollover, the first step should always be to actually open your account with your new account administrator and tell them that you’re planning to roll your investments over. That way, they’ll know your money is coming their way and be prepared to receive it.
If they get a check by surprise, there’s a chance they might think it’s a regular contribution, not a rollover. That would mean you’d get hit by those massive taxes we mentioned above, and it would count toward — and possibly push you over — your annual contribution limit, too (whereas a rollover wouldn’t). Basically, the whole thing would probably get pretty messy.
5. Not talking to a tax pro about company stock
If your old company gave you company stock as part of your compensation, and if that stock is inside your old 401(k), there are some tax benefits you’d give up if you rolled those shares into a different account. So if you’re in this situation, ask a tax pro for help figuring out what’s best for you before you roll over your whole 401(k).
Keep an eye out for these five common mistakes, and you should be golden. Good luck in that new job (not that you need it!).
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