401(k) Rollover Mistakes That Cost Retirees Thousands

Rolling a 401(k) into an individual retirement account (IRA) feels like paperwork, and several of the mistakes it invites are permanent. The expensive ones cluster in three places: taking the money personally when a transfer was available, breaking the once-per-year IRA rollover limit, and moving appreciated company stock before checking net unrealized appreciation (NUA).

The Two Rules That Create Surprise Tax Bills

When you take a distribution directly, your plan is required to withhold 20% for federal taxes. Ask for $500,000 and you receive $400,000, then have 60 days to deposit the full $500,000 into an IRA, finding the missing $100,000 out of pocket. Miss the deadline or come up short, and the shortfall is a taxable distribution, plus a 10% early-withdrawal penalty if you are under 59½.

The IRS also allows only one indirect (60-day) rollover between IRAs in any 12-month period, across all your IRAs combined. A second one inside that window is a taxable distribution. On a $200,000 mistake at a 32% marginal rate, that is $64,000 in federal tax alone, before state taxes.

Both disappear the same way. Request a direct trustee-to-trustee transfer: the old plan sends money straight to the new custodian. No withholding, no 60-day clock, and no limit on how often you do it.

NUA: The Company Stock Rule

If your 401(k) holds company stock that appreciated inside the plan, rolling it into an IRA may cost you money. Under NUA rules, you can instead take a lump-sum distribution of the stock, pay ordinary income tax only on the original cost basis, and sell the shares outside the plan at long-term capital gains rates on the growth.

An illustrative example: $180,000 in company stock with a $40,000 cost basis. Rolling it into an IRA would eventually tax all $180,000 as ordinary income. Using NUA, only $40,000 hits the ordinary rate and the remaining $140,000 of gain is taxed at long-term capital gains rates when sold. Assuming a 37% ordinary rate and the 20% top long-term rate, that 17-point gap on $140,000 is about $23,800 in federal tax. This is tax planning work, decided before assets move anywhere.

When Leaving Money in the Old Plan Makes Sense

Two situations favor staying put. First, if you retire at 55 or older in the year you separate from service, 401(k) distributions avoid the 10% early-withdrawal penalty. IRAs do not get that exception until age 59½. Second, some 401(k) plans offer institutional-class funds with expense ratios lower than many retail share classes; 0.03% on a bond index fund against 0.15% is worth running.

The Four Options and Their Trade-Offs

When you leave an employer, a 401(k) generally has 4 possible paths:

1. Leave it in the old plan (if the plan allows): keeps the age-55 exception, the plan's investment menu, and federal creditor protection; you are limited to that menu and have one more account to track.
2. Roll it into a new employer's plan (if it accepts roll-ins): consolidates workplace savings and keeps pre-tax money out of the IRA pro-rata calculation; you take on the new plan's menu, costs, and withdrawal rules.
3. Roll it into an IRA: usually opens a broader investment choice and flexible withdrawals; costs, creditor protection, and penalty exceptions differ, and company stock rolled in loses NUA treatment.
4. Take a cash distribution: gives immediate access; the money is taxed as ordinary income, 20% is withheld, and the 10% penalty may apply.

Sporos offers Rollover services, with the pros and cons of all 4 rollover options laid out against your own plan's rules.

The Takeaway

Two facts change the right answer: whether the plan holds low-basis company stock, and how old you were in the year you separated from service.

Consider a hypothetical retiree who did the safe thing: a clean direct rollover, processed without an error, that permanently gave up NUA treatment on appreciated stock and the age-55 penalty exception. No correction filing exists for it.

Before anything moves, checking those two facts against your own statement is worth a conversation.

The information provided is for educational purposes only and does not constitute investment, legal, or tax advice. Consult with qualified professionals for guidance specific to your situation.