When someone who is enrolled for a 401(k) plan switches job, they have to take the crucial step of rolling over their assets from their current 401(k) account to another qualified account. 401(k) rollovers must be handled with extreme care as, in the event of a mistake, one can end up not only with severe taxes and penalties but also lose a chance of higher earnings from the amount that was invested. However, even with lots of cautionary advice, people still do end up making mistakes with a 401(k) rollover. These are some of the mistakes one should avoid in order to escape taxes and penalties on their tax deferred savings.

• Withdrawing the funds

Many a times, employees think that since switching jobs qualifies them to make a withdrawal from their 401(k) account, they should take it. However, this has a major pitfall. Money that is deferred to a 401(k) account is pre-tax and meant for future retirement saving, hence the government imposes a 10% withdrawal penalty on the amount if the employee is below the age of 59 ½. Also the withdrawal will be considered as ordinary earnings and one will have to pay income tax on it during that year. Usually, in such a case, the employee is left with only approximately 60-70% of the withdrawn amount. Had the money been in the account, it would have earned capital gains in the long term. Hence by withdrawing, the employee loses on potential gains from such investments.

• Failing to redeposit within 60 days

If the employee does make a mistake of withdrawing the funds, there can still be a solution to escape the taxes and penalties.

When an employee chooses to make an ‘indirect’ rollover, that is chooses to deposit the money into other qualified retirement plan manually, the employer or the plan administrator writes the employee a check. It should be noted that this check is not for the complete amount of the 401(k) account. By law, employers are needed to withhold 20% of the amount for tax (which is directly sent to the IRS).  This amount is reimbursed or adjusted when the employee files their taxes for that financial year. In case the employee fails to deposit that amount (and also fails to mention so in the tax filing) in the new retirement plan, the amount is considered as a withdrawal and taxed accordingly along with a 10% withdrawal penalty if the employee is below the age of 59 ½.

Hence, it is almost always advised to make a direct rollover as it saves one all the connected hassle. One should check with their employer about the options they have; they should preferably do this before leaving the job or applying for a rollover.

• Not doing a rollover

Another common mistake many employees make is of not rolling over the funds from their 401(k) account with former employer. By law, even if an employee switches jobs, the employer has to retain and maintain the employee’s 401(k) account. However, the employer or plan administrator has the liberty to charge a fee for maintaining the account. This can become problematic if the employee has multiple 401(k) accounts or multiple retirement account.

Transferring the funds to a single account enables the employee to a greater degree of control with their investments. This factor becomes more important when one considers the human factors. As one progresses in his/her career and switches jobs multiple times, they may forget about the previous plans. This can be even more detrimental in any unfortunate event like death or complete disability of the account holder when the beneficiary knows nothing about such previous plans.

• Not considering 401(k) loans

Not considering or worse, forgetting that one has an outstanding 401(k) loan with their employer before switching jobs can land the employee in great financial trouble. Generally as per the rules, one has to repay the loan within 60 days of switching jobs. If one fails to repay within this time, the loan is considered as a withdrawal which attracts all the taxes and penalties. This is one of the reasons why it is mostly advised against taking a 401(k) loan.

• Asking advice from the wrong people

Generally, people ask advice regarding 401(k) rollovers from their friends or employers. It should be very prominently noted that majority of the times, employers and friends (who are not financial advisors) are not licensed or qualified to provide such advice. The work should be left to the professional if one finds the process of rollover difficult to comprehend. Financial advisors or tax attorneys can point the person in the right direction.

• Other general  mistakes

Not doing proper research before a rollover can cost one dearly. Especially if they do not consider rules such as the IRA rule where one can rollover the funds only once in 12 months, or the same property rules. Breaking either rule will incur taxes and/or penalties. Hence, they should be properly considered.

Since such mistakes can attract taxes and penalties, one should be extremely careful when doing a rollover. If they find it hard to comprehend the details of the rollover, they should consider consulting a financial advisor or tax attorney to help them through it. Again, it should be noted that not doing a rollover in the first place can be the primary mistake.