This Common 401(k) Rollover Mistake Costs Americans Billions of Dollars

The Wall Street Journal reported that “over four million Americans will reach traditional retirement age in 2024, more than any other time in history” and that with it, “workers miss out on billions in investment gains by pulling retirement savings out of the stock market after switching jobs — often without meaning to.”

As more and more of the baby boomer generation starts to retire, more and more of them are finding out that they could have cashed in on an opportunity but did not, all because of one mistake that is all too common: not properly rolling over their 401(k) plans .

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Why does this 401(k) mistake happen, and how can you make sure it doesn’t happen to you before retirement? GOBankingRates asked several financial and retirement planners to share why this happens and tips to avoid this common 401(k) rollover mistake that costs Americans billions of dollars .

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Properly Rolling Over Your 401(k)

“Rolling your retirement savings out of an old employer plan, such as a 401(k), comes with benefits, including greater flexibility to make and manage investment,” said Charlie Pastor, CFP, contributing expert at The Motley Fool Ascent .

But Pastor invoked the old adage that “Great power comes with great responsibility.”

“Once you move funds out of your employer’s retirement plan, it’s up to you to invest those funds in a suitable portfolio — or any investment at all,” Pastor said.

“Part of the reason why 401(k)s are such an effective saving vehicle is that they are often the ‘easy’ button of retirement savings accounts,” Pastor explained. “In many cases, a plan administrator does all the work of opening accounts, choosing an investment menu and investing contributions automatically.”

For some employees, Pastor noted that setting up a 401(k) is a one-and-done affair. They can choose a contribution rate and pick an investment, typically a self-managing target date fund. But rolling over a 401(k) takes effort and planning.

“I’ve seen many clients make the mistake of leaving their 401(k) balances in the old employer’s plan or cashed out altogether,” said David L. Blain, CFA, CEO of BlueSky Wealth Advisors , noting that this move costs them dearly in lost investment returns and unnecessary taxes and penalties.

So how can this be avoided?

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Roll Over Balances to an IRA

The best way to make sure you are taking advantage of all the retirement money afforded to you is to roll over the 401(k) balances into an IRA.

“This means the check is made out to the new IRA custodian, so no taxes are withheld,” said Ben Klesinger, CEO of Reliant Insurance Group and Helping Hand Financial .

“Many people don’t realize that after leaving a job, they can no longer contribute to that old 401(k) and will likely face higher fees, limiting returns. For most, rolling into an IRA is the best approach,” Klesinger said.

“When leaving an employer, I always advise clients to roll over their 401(k) balances into an IRA,” Blain explained. “This allows them control over investment options and usually lower fees. The key is to do a direct rollover to avoid the 20% withholding tax. As long as the check is made out to the new IRA custodian, no taxes are withheld.”

Similarly to Klesinger, Blain also noted that a significant number of people don’t realize that once separated from service, they typically can no longer make contributions to the old 401(k), and they can frequently end up facing higher fees.

Keep Money in Your 401(k) If You’re Retiring Before 60

Experts also advised that for those planning to take distributions before age 59 1/2, leaving some funds in the old 401(k) could make sense to avoid the 10% early withdrawal penalty.

“An IRA provides more investment flexibility and control,” Blain said. “For most, a rollover IRA is the best approach. But for some, especially those who may need to take distributions before age 59 1/2, leaving some money in the old 401(k) could make sense.”

Do Not Cash Out Your 401(k)

Across the board, experts said that cashing out your 401(k) would cause the most damage and put your retirement planning in severe jeopardy.

“The most important thing is to avoid cashing out the 401(k), as that results in immediate taxation of the entire balance and typically a 10% early withdrawal penalty,” Blain said. “With good planning, those 401(k) balances can provide income for life after retirement. But bad decisions early on can slash that nest egg permanently.”

Do Your Rollover Homework

“There are a few options available to overwhelmed investors, but the best advice is to not get distracted by the ocean of choice,” Pastor explained.

He pointed out how “investors should research their options, keeping an eye out for funds that match their time horizon and risk tolerance.”

Daniel Ray, founder and CEO of PinnacleQuote , suggested those lost among all their options seek guidance from a financial advisor, as it “can help individuals make smart choices and avoid common pitfalls.”

Being aware of your options and other factors can make a big difference. “Understanding market trends and investment options, and staying informed and proactive about retirement savings, can make a big difference in securing one’s financial future,” Ray said.

“Many brokers also offer tools to narrow down your options and make the decision easier. And you can always turn to a qualified financial advisor to help. Remember to keep calm and carry on. Your retirement is counting on it,” Pastor said.

This article originally appeared on GOBankingRates.com : This Common 401(k) Rollover Mistake Costs Americans Billions of Dollars