Avoiding the Major Rollover Mistakes

Retirement plan rollovers are in the news. Specifically, rollovers of 401(k)s and other qualified retirement plan accounts to individual retirement accounts (IRAs) have been making headlines. Last month we addressed the new fiduciary standard the Department of Labor imposed on those who work with IRAs. The rules were generated because the government disapproves of the decisions many people make regarding rollovers of their employer plans to IRAs.

You don’t need 1,200 pages of regulations to tell you how to manage your 401(k), IRAs and other retirement accounts. The regulations, in fact, provide little useful information for making decisions about rollovers or help in avoiding the key rollover mistakes people make.

About 62% of recent retirees with substantial assets in 401(k)s and similar types of plans rolled the accounts to IRAs, according to a survey released by the Center for Retirement Income at The American College of Financial Services. It is interesting that of those who rolled over their money, about eight of 10 worked with a financial advisor. Of those who didn’t do rollovers, about 56% made their decisions with a financial advisor.

Here’s a framework for making decisions about 401(k) accounts that will enhance your financial security.

You generally have these options when leaving an employer: leave your money in the 401(k) plan (though a few employers still discourage this); transfer it to the 401(k) plan of a new employer, if its plan allows; take the distribution in cash; or rollover the account to an IRA.

First, consider any advantages of keeping the money in the current 401(k) plan.

The 401(k) plans of many small- and medium-size employers, and even some large employers, aren’t good. They have limited investment options. The funds offered often aren’t among the best available in their categories, and only a few investment categories are offered. The costs can be high. There also might be limits on how often changes can be made in the investments and when money can be taken from the plan.

Some plans, however, especially those at larger employers, can be very good. The employers negotiate low costs and good investment options. For example, the funds might be institutional class funds that have lower expenses than the retail mutual funds you’ll buy through an IRA. Large employers might pay some of the account expenses instead of passing them through to employees.

An employer that takes its 401(k) seriously seeks out the best funds in each asset category, offers a wide range of asset categories instead of just the basic five or so, and might work with investment firms to design target date plans or similar asset allocation funds that are better than the off-the-shelf products at most fund families. An IRA offers more investment choices, but a well-run 401(k) narrows the choices down to the better ones you’d find and negotiates lower fees.

A 401(k) plan also is likely to have a stable value fund option, which is a good place to hide while earning a decent yield when you want to be out of the markets or are mapping out your future. While there are limits to entering and leaving a stable value fund, it should pay a higher yield than a money market fund.

A downside, and perhaps it is a major disadvantage, to staying with even a good 401(k) plan is that you might not be able to consolidate your investment assets at one financial services firm.

You also need to consider the long term. Some 401(k) plans offer good annuity options when it is time to take retirement distributions. Or they allow unlimited periodic distributions or are flexible about setting up distribution schedules. Others effectively discourage people from maintaining their accounts after retiring by limiting distribution options and making changes for non-employees cumbersome. Some plans require fast payouts to beneficiaries who inherit 401(k)s. Check to see what the plan offers retirees and also what it offers to a beneficiary who inherits.

When a 401(k) plan has major drawbacks, your best action is rolling over the 401(k) plan to an IRA or a new employer’s plan. If you are joining a new employer that will accept rollovers, consider the same factors in that plan. Determine if the new employer’s plan is better than an IRA rollover. You’re required to put new deferrals into the new employer’s 401(k) plan, but you don’t have to roll over your old account to it.

When you decide to roll over an account to an IRA, shop around for the IRA. This is where the new government regulations have their biggest impact if you’re using a financial advisor. Government officials believe many people are persuaded to move their money from low-cost 401(k) accounts to other accounts with high fees and expenses. Don’t assume the IRA offered by the current 401(k) administrator or custodian is best. Consider investment options, fees, and the different ways you can access the account. Take a look at the list of fees charged for all services. Some IRA custodians offer “no-fee IRAs,” meaning they don’t have annual maintenance fees, but then charge a fee every time you want to take money out or make any other transaction.

Government regulators believe that people are persuaded to roll over their retirement accounts to buy expensive, complicated financial products. No doubt some people are talked into leaving a 401(k) plan and rolling over their assets to buy investments with higher expenses and commissions. That’s because they analyze the decision incorrectly. First, decide the types of assets you want to own with that money. Then, decide if the current plan, an IRA rollover, or some other vehicle is the best way to own those assets. That’s the framework I laid out above.

Once you decide to roll over a 401(k) account to an IRA or new employer plan, your work isn’t finished. There are different ways to do the rollover, and you need to be sure it’s done right. A mistake at this point could cost you more than excess fees and commissions.

One way to roll over an account is to have the plan make out a check to you. After the check is issued, you have 60 days to deposit the account balance in a qualified IRA or employer retirement plan. Fail to make the deposit within 60 days and the distribution is included in your gross income. You’ll owe income taxes and, if you’re under age 59½, a 10% early distribution penalty, too.

A lot can go wrong in those 60 days. You could be in an accident, get sick, have a family emergency, or lose track of things. Also, you could do everything right only to have the new custodian put the money in the wrong account. All of these things and more have happened to people. The IRS allows you to ask for a waiver of the 60-day requirement if you think you have a good excuse. But it’s expensive to have a proper waiver filed, and the IRS doesn’t waive the requirement very often.

Generally, you’ll receive a waiver only if the firm receiving the rollover made a mistake, you were free of fault and you did everything you could to correct the mistake immediately after you learned or should have learned about it. The IRS even has denied waivers when someone died within the 60-day period.

Another reason not to take the check is that the plan has to withhold 20% for income taxes. You have to come up with that 20% from other sources and deposit it to the new account to make the rollover complete and tax free. You’ll get a refund of the withholding after filing your income tax return for the year.

My advice: Don’t take a check from a retirement plan. You want a trustee-to-trustee transfer. Have the administrator of the plan you’re leaving transfer the money directly to the new IRA or employer plan. You’ll first have to open the new IRA or other account. With an IRA, you complete a form requesting the IRA custodian to have the funds transferred from the old account. The IRA custodian will contact your 401(k) plan administrator and be sure the account is transferred. There’s no 60-day rule for a trustee-to-trustee transfer.

In either case, follow up. Once the account is transferred, be sure it is deposited in an IRA or your new employer’s retirement plan. Firms sometimes make a mistake and deposit transfers into taxable accounts instead of IRAs. You don’t want the hassle of correcting this mistake weeks or months after it occurred.