3 common mistakes when rolling over a 401k

Rolling over your 401k is a common thing, unfortunately, you could be making some big mistakes when doing so. It isn’t about leaving the 401k, it is about knowing all the advantages when making a rollover. In the long run, knowing these three common mistakes can save you a lot of money. Here are 3 common mistakes that you should avoid when making a rollover from your employer retirement plan.

Do you have company stock?

A lot of employer retirement plans give stock options for their plans. If you are one of them, there is something you should learn about before making a rollover with your 401k. If you are able to, there is something called Net Unrealized Appreciation. This usually makes sense when you started with the company early on when the stock was much lower, and now the stock has appreciated in value. The benefit is that you can recognize the stock when you received it as ordinary income, then you receive the gains as capital gains, which is typically much lower tax than ordinary income. The advantage is clear, you can save a lot of money on taxes. This isn’t all that easy, so please make sure you are working with your financial advisor or CPA to make sure this is right for you.

Do you have after tax money in your 401K?

Most of your money in your 401k is typically made up of pre-tax dollars. Sometimes, you may have some after tax dollars also. If you do have after tax money, you will have to take that out of your 401k as well. You can’t select which one you want, it will come out proportionately. The good news, instead of rolling youafter tax contributions to a checking or brokerage account where you will continue to pay taxes on the interest, dividends, and gains, you can roll it to a Roth IRAwithout any tax implications. The benefit of a Roth is that it grows tax-freehand the gains are tax-free. You must do this when it comes out of your retirement plan or must do it within 60 days to qualify. Again, meet with your advisor or CPA to make sure you are following the rules.

Understand the indirect vs direct rollover.

When rolling over your retirement plan money to an IRA, it is usually best to do a direct rollover. That way, you don’t have to worry about applying the funds to your IRA account within 60 days. If you don’t, then you will recognize the money as a taxable distribution. The other downside to an indirect rollover is that you can only do one per 12 months. If you do more than one, the IRS will count it as a distribution, which then you will have to pay taxes on. When you make a direct rollover from institution to institution, then you can do as many rollovers in any period of time as you want and you won’t have to worry about the 60-day rule either.As you can see, rolling over from your retirement plan from your employer can be tricky if you don’t understand all the rules and regulations. It isn’t always as simple as rolling the money over, and you could be costing yourself thousands of dollars in tax money and penalties. This is why it is generally a good idea to sit down with a financial advisor or CPA to review your options to make sure you are doing the best thing you can.

Transcripiton

Hi everyone. Vince Oldre, certified financial planner. I want to talk to you about three common mistakes people make when rolling over their 401(k) to an IRA.
Rolling your 401(k) to an IRA isn’t all that hard, but there can be things you might be making some big mistakes on. One of the biggest ones that I see, is that people will move their company stock without doing what is called net unrealized appreciation, or NUA. It isn’t always the best thing to do, net unrealized appreciation, but sometimes, if you’ve been with that company for a very long time and you have a very low cost basis, which means that let’s say for example, you were given stock at $2 a share, now it’s grown to $10 a share. The way it works is that you get that $2 as ordinary income taxes. Then you get the rest as capital gains, instead of ordinary income taxes, as you normally would if you moved it to an IRA.
The reason why this is advantageous is that capital gains tax is generally lower, or it can be lower than your ordinary income taxes. What you want to do is before you move your money to an IRA, you might want to look at whether you have company stock. If you do, you might want to look at whether or not you should do what is called net unrealized appreciation. That’s where you need to either meet with a financial advisor or CPA that really knows what they’re doing when putting that together for you.
The next biggest mistake we see is that a lot of you might have some after-tax money in your 401(k). Now not everyone has after-tax money in your 401(k) because typically, most of the money is going to the 401(k), which is pre-tax dollars. But if you contribute to your 401(k) and there was after-tax money, the benefit that you have there is that you can convert that money that’s after-tax dollars to a ROTH IRA, instead of to your IRA.
The reason why that’s gonna be more advantageous to you, is because when that money is now in the ROTH IRA, it’s gonna grow tax-free and when you take it out, it’s tax-free. One of the biggest mistakes we see is that people will just move their money over, without thinking about putting that type of money, the after-tax money into your ROTH IRA account.
The last one that we see as a new issue, is a indirect rollover versus a direct rollover. An indirect rollover, that means you have to move the money within 60 days. What will happen is you ask for the rollover, the 401(k) company will send you the check and then you have 60 days to put that check into an IRA account. If you don’t, you then owe taxes, or you recognize all that money as income.
To do a direct rollover, they still might send you a check, however the check is made out to the custodian or to the institution and not to you. The check might be sent to you, it’ll say, “To Fidelity” or “To TD Ameritrade, for the benefit of John Jones.” So then, that would be a direct rollover, and then you don’t have a 60 day rule.
The issue with the 60 day rule is that you can only do one per every 12 months. If you do an indirect rollover, that means that’s the one that you have for 12 months. If you do another one within that same timeframe, you actually have to recognize that money as ordinary income taxes. You cannot roll that money over, they’re gonna say that you recognize that money, because there was a couple that were kind of playing a loophole and doing a bunch of rollovers. So they kind of closed that loophole, so you can no longer do that. The best thing to do is just do a direct rollover and avoid that headache altogether.
These are the three most common mistakes that we see, although they’re not the only ones that we see. If you want to make sure that you’re getting the best help when it comes to rolling your money from your 401(k) to an IRA, make sure to come to one of our education workshops or educational events. Or download our free retirement guide, get some more information on making sure that you don’t make mistakes, like you might with your 401(k).

3 Common Mistakes When Rolling Over A 401K
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