The 5 Most Common 401k Rollover Mistakes — And How to Avoid Them

401k rollovers have gotten complicated with all the recycled listicles and financial-firm “guides” flying around. As someone who spent three years working adjacent to a financial planning office, I learned everything there is to know about what actually goes wrong — not in theory, but in practice. I watched people walk in excited about their retirement accounts and walk out having just triggered a tax bill they never saw coming. Same five mistakes. Almost every time. Almost always preventable. And almost always traced back to not knowing one specific rule before they touched anything. Here’s what those mistakes actually look like.

Mistake 1 — Taking an Indirect Rollover Instead of a Direct One

This one genuinely keeps me up at night. The setup sounds innocent enough: you leave a job, you want your 401k moved to an IRA, and your old employer cuts you a check. Simple, right? You deposit it into your new account. Done.

Not even close.

The moment that check gets made out to you — not to your new IRA custodian — the IRS requires your plan to automatically withhold 20% for federal taxes. Non-negotiable. So a $100,000 401k becomes an $80,000 check in your hand, with $20,000 already sent off to the IRS as a withholding deposit.

Here’s the trap. You have 60 days to deposit the full $100,000 — not $80,000, the full $100,000 — into a qualifying IRA to avoid taxes and penalties. That missing $20,000 has to come out of your own pocket first. You’ll get it back eventually as a tax refund, but you have to front it. Cash you may not have sitting around in a checking account.

Miss the deadline — or come up short — and the shortfall gets treated as a taxable distribution. Ordinary income tax applies. Stack a 10% early withdrawal penalty on top of that if you’re under 59½. On a $100,000 rollover, someone in the 22% bracket could realistically owe $32,000 in taxes and penalties on money they fully intended to keep in retirement savings. That’s what “just deposit the check” actually means.

What to Do Instead

Request a direct rollover — trustee-to-trustee transfer is the technical term. You instruct your old plan to send the money straight to Fidelity, Schwab, Vanguard, wherever the IRA is opening. The check goes to the custodian, not to you. No withholding. No 60-day clock ticking. The money moves cleanly.

Don’t make my mistake — well, technically my colleague’s father’s mistake. He lost nearly $14,000 to this exact scenario because a benefits administrator told him to “just deposit the check within 60 days” without mentioning the withholding, or that he’d have to personally cover the gap. Call your new IRA custodian first. They’ll walk you through the direct rollover paperwork, usually at no cost, in a single phone call.

Mistake 2 — Forgetting About Required Minimum Distributions

Probably should have opened with this section, honestly — because if you’re 73 or older and you miss this one, you’re staring down a 25% excise tax on the amount you should have distributed. Not a typo.

But what is an RMD? In essence, it’s a mandatory annual withdrawal the IRS requires from your traditional 401k once you hit age 73. But it’s much more than that — because RMDs cannot be rolled over. They are taxable income, full stop. The rollover process doesn’t exempt them, doesn’t pause them, doesn’t care.

Frustrated by complicated account paperwork, most people initiating a rollover just move the entire balance — including that year’s RMD amount — directly into an IRA. Rolling over an RMD gets treated as an excess IRA contribution. That triggers a 6% penalty on the excess for every year it sits uncorrected. The IRS is not sympathetic about this one.

The Correct Sequence

1. Calculate your RMD for the current year before you initiate anything.
2. Take the RMD as a distribution — pay the income tax on it, move on.
3. Roll the remaining balance via direct rollover into your IRA.

If you’re mid-year when you start the rollover, the RMD still applies to the full account balance as it existed on December 31 of the prior year. Doesn’t matter that the money is in transit. The IRS wants its distribution first — sequence matters enormously here.

Mistake 3 — Rolling Into a Higher-Fee Account

This one moves slowly. Nobody sends you a penalty notice. There’s no missed deadline. You just quietly pay more — every single year — until the compounding math finally reveals the damage decades later.

Large employer 401k plans often have access to institutional share classes of index funds with expense ratios as low as 0.02% or 0.03%. Vanguard’s VIIIX — the institutional version of their S&P 500 fund available in large plans — runs 0.02%. That’s $2 per year on every $10,000 invested.

Roll that same money into a retail IRA and you might end up in a retail equivalent at 0.14%, or worse, some actively managed fund your new provider nudged you toward at 0.75% or higher. On a $200,000 rollover, the difference between 0.02% and 0.75% is roughly $1,460 per year in fees. Over 20 years with compounding, that’s the kind of number that makes you sit down slowly.

What to Check Before You Move

Pull the Summary Plan Description from your old 401k — it lists the expense ratios on every fund you’re invested in. Then look at the fee schedule and fund options at your target IRA custodian. Fidelity, Schwab, and Vanguard all offer zero-expense-ratio index funds in retail IRAs now — Fidelity’s FZROX is literally 0.00% — so the gap has genuinely narrowed. But if someone steers you toward a managed account or an annuity wrapper inside an IRA, pump the brakes and read every line of the fee disclosure.

That’s what makes this decision endearing to us DIY investors — sometimes the boring move is staying put. If your old 401k has genuinely excellent institutional funds, rolling over just because you left the job isn’t required. That option exists.

Mistake 4 — Missing the Tax Benefits of Net Unrealized Appreciation

Most obscure mistake on the list. Also the one where I’ve seen the biggest dollar amounts left on the table — tens of thousands for people sitting on significant company stock inside their 401k.

But what is NUA? In essence, it’s a special IRS tax treatment for employer stock held inside a 401k. But it’s much more than that — it’s potentially a massive difference in your lifetime tax bill. Here’s the plain version: if your company’s stock grew significantly inside your plan, you can — under specific conditions — take an in-kind distribution of that stock instead of rolling it over. You pay ordinary income tax only on the original cost basis. The appreciation — the NUA — gets taxed at long-term capital gains rates when you eventually sell. For most people, that’s 0%, 15%, or 20%.

Roll that same stock into a traditional IRA instead? Every dollar of it eventually gets taxed as ordinary income on withdrawal. If you’re in the 32% bracket in retirement, the gap between 32% ordinary income and 15% capital gains on a large block of appreciated stock is serious money.

A Simplified Example

Say you have $150,000 in company stock inside your 401k — original cost basis of $30,000, NUA of $120,000.

• Roll it into an IRA: Eventually withdraw $150,000, pay ordinary income tax on all of it. At 24%, that’s $36,000.
• Take the NUA distribution: Pay ordinary income tax on the $30,000 basis ($7,200 at 24%), then 15% capital gains on the $120,000 NUA when you sell ($18,000). Total: $25,200.

That’s roughly $10,800 saved in this one example. With larger balances and more decades of appreciation, the gap gets bigger. A tax advisor — even just a one-hour consultation — is worth every penny before you roll over any account with employer stock in it.

Mistake 5 — Not Considering a Roth Conversion at the Rollover Decision Point

A rollover is a natural inflection point. You’ve left a job, you’re reorganizing your financial life, and you’re deciding where this money lives next. Most people default to rolling a traditional 401k into a traditional IRA — apparently without stopping to ask whether right now might be the single best moment to convert some or all of it to Roth.

Roth conversions are most efficient in low-income years — early retirement, a career transition, a sabbatical, a year spent launching a business out of a spare bedroom with little initial revenue. Converting $50,000 from traditional to Roth in a 12% bracket year costs $6,000 in taxes today. Do that same conversion in a 24% bracket year and it costs $12,000. Same money. Twice the tax bill. Just different timing.

The rollover moment is often a low-income year by definition. You’ve just left a job. If there’s a gap before the next income source starts, your taxable income may be lower than it’ll be for a long time. That’s the window — and most people sleepwalk right past it because “rollover to traditional IRA” is the path of least resistance.

How to Think About This Decision

You don’t have to convert everything. Partial conversions are common — you convert up to the top of a given bracket and stop. Filling the 12% bracket is a popular strategy. You pay a modest known rate now in exchange for tax-free growth, tax-free withdrawals later, and — starting in 2024 under SECURE 2.0 — no RMDs on Roth accounts ever.

A fee-only financial planner charging a flat rate — something like $250 to $500 for a standalone session, no ongoing management required — can model this against your actual numbers. The Roth conversion question at rollover is one of the highest-leverage planning moments in a person’s entire retirement timeline. Worth the call.

The Bottom Line

These five mistakes — indirect rollovers triggering automatic withholding, overlooked RMDs, fee creep into retail fund classes, missed NUA treatment on employer stock, defaulting past a Roth conversion window — are not rare edge cases. They happen constantly. They happen to financially literate people who are paying attention. They happen because the retirement account system is genuinely complicated, and most of the available information comes from institutions with something to sell.

The common thread across all five: the expensive outcome is almost always avoidable with one phone call or one hour of reading made before initiating the rollover. Once the distribution processes, your options narrow fast. The 60-day clock starts. The NUA election window closes. The conversion math shifts.

Do the reading first. Ask the custodian questions — they’re used to it. If there’s employer stock involved or significant assets at stake, spend the money on a fee-only advisor for a single session. Getting this right almost always costs less than getting it wrong.