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

Most people researching 401k rollover mistakes to avoid find the same recycled listicles written by companies that want to manage their money. I’m not here to sell you anything. I spent three years working adjacent to a financial planning office — close enough to watch people walk in excited about their retirement accounts and walk out having just triggered a tax bill they didn’t see coming. The mistakes were almost always the same five. They were almost always preventable. And they almost always came down to not knowing one specific rule before initiating the rollover. This article covers all five.

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

This is the one that genuinely keeps me up at night when I think about how many people get hit by it every year. The concept sounds simple enough: you leave a job, you want to move your 401k to an IRA, and your former employer writes you a check. That’s it, right? You deposit the check into your new IRA. Rollover complete.

Wrong. Here’s what actually happens.

The moment your employer writes that check to you personally — not to your new IRA custodian — the IRS requires your plan to withhold 20% for federal taxes. Automatically. Non-negotiable. So if your 401k had $100,000 in it, you receive a check for $80,000. The other $20,000 goes to the IRS as a withholding deposit.

Now here’s the trap. You have 60 days to deposit the full $100,000 into a qualifying IRA to complete the rollover and avoid taxes and penalties. Not $80,000. The full $100,000. That means you need to come up with the missing $20,000 from your own pocket — cash you may not have — to cover the amount that was withheld. You’ll eventually get that $20,000 back as a tax refund when you file, but you have to front it first.

Miss the 60-day deadline, or come up short on the deposit? The entire shortfall gets treated as a taxable distribution. Add your ordinary income tax rate on top of that, then stack a 10% early withdrawal penalty if you’re under 59½. On a $100,000 rollover, someone in the 22% bracket under age 59½ could owe $32,000 in taxes and penalties on money they fully intended to keep in retirement savings.

What to Do Instead

Request a direct rollover — also called a trustee-to-trustee transfer. You tell your old plan: send the money directly to Fidelity, or Schwab, or Vanguard, or wherever you’re opening the IRA. The check gets made out to the new custodian, not to you. No withholding. No 60-day clock. The money moves cleanly.

Burned by this personally? No — but I watched a colleague’s father lose nearly $14,000 to this exact scenario because a benefits administrator told him “just deposit the check within 60 days” without mentioning the withholding part or that he’d need to cover the gap himself. Call your new IRA custodian first. They’ll walk you through the paperwork for a direct rollover at no cost.

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 looking at a 25% excise tax on the amount you should have distributed. That’s not a typo.

Here’s the rule: once you hit age 73, the IRS requires you to take a Required Minimum Distribution (RMD) from your traditional 401k each year. These distributions cannot be rolled over. They are taxable income, period. The rollover process does not exempt them.

The mistake happens when someone decides to roll over their entire 401k balance — including the RMD amount for the current year — into an IRA. Rolling over an RMD is treated as an excess contribution to the IRA. That triggers a 6% penalty on the excess amount for every year it sits there uncorrected. The IRS is not sympathetic about this one.

The Correct Sequence

1. Calculate your RMD for the current year before initiating any rollover.
2. Take the RMD as a distribution — pay the income tax on it, move on.
3. Roll over the remaining balance via direct rollover to your IRA.

If you’re in the middle of a year when you initiate 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 moving. The IRS wants its distribution first. Sequence matters enormously here.

Mistake 3 — Rolling Into a Higher-Fee Account

This one is slower-moving than the others. Nobody sends you a penalty notice. There’s no 60-day deadline you miss. Instead, 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. We’re talking expense ratios as low as 0.02% or 0.03%. For context, Vanguard’s institutional VIIIX — the version of their S&P 500 index fund available in large plans — carries a 0.02% expense ratio. That’s $2 per year on every $10,000 invested.

Roll that same money into a retail IRA and you might end up in VFINX or a similar retail equivalent at 0.14%, or worse, in some actively managed fund your new IRA provider nudged you toward at 0.75% or higher. On a $200,000 rollover, the difference between 0.02% and 0.75% is about $1,460 per year in fees. Over 20 years with compounding, that gap is not small. It’s the kind of number that makes you sit down.

What to Check Before You Move

Pull the Summary Plan Description from your old 401k. Find the expense ratios on the funds you’re actually 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 their retail IRAs now — FZROX is literally 0.00% — so the gap has narrowed substantially. But if someone is steering you toward a managed account or an annuity wrapper inside an IRA, that’s where you need to pump the brakes and read every line of the fee disclosure.

Sometimes staying in the old 401k is actually the better move, particularly if the plan has genuinely excellent institutional funds and you’re not looking to consolidate accounts for simplicity. That option exists. You don’t have to roll over just because you left the job.

Mistake 4 — Missing the Tax Benefits of Net Unrealized Appreciation

This is the most obscure mistake on the list. It’s also the one where I’ve seen the biggest dollar amounts left on the table — we’re talking potential tax savings in the tens of thousands for people who had significant company stock in their 401k.

Net Unrealized Appreciation, or NUA, is a special tax treatment that applies to employer stock held inside a 401k. Here’s how it works in plain terms: if your company’s stock has grown significantly inside your 401k, you have the option — under specific conditions — to take an in-kind distribution of that stock rather than rolling it into an IRA. When you do that, you only pay ordinary income tax on the original cost basis of the shares. The appreciation — the NUA — gets taxed at long-term capital gains rates when you eventually sell, which for most people is either 0%, 15%, or 20%.

Roll that same stock into a traditional IRA instead, and 100% of its value gets taxed as ordinary income when you withdraw it. If you’re in the 32% bracket in retirement, the difference between 32% ordinary income and 15% capital gains on a large block of appreciated stock is significant money.

A Simplified Example

Say you have $150,000 in your company’s stock inside your 401k. Your original cost basis — what the company contributed and what you paid — was $30,000. The NUA is $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 in taxes.
• Take the NUA distribution: Pay ordinary income tax on the $30,000 basis ($7,200 at 24%), then pay 15% long-term capital gains on the $120,000 NUA when you sell ($18,000). Total: $25,200.

That’s roughly $10,800 in this example. In real situations with larger balances and decades of appreciation, the gap is bigger. Talk to a tax advisor before rolling over any account that contains employer stock. This specific question — NUA treatment or IRA rollover — is worth the cost of a one-hour consultation.

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 making a decision about where this money lives next. Most people default to rolling a traditional 401k into a traditional IRA without stopping to ask whether this moment — right now — might be the best possible time to convert some or all of it to Roth.

The logic is straightforward: Roth conversions are most efficient in low-income years. Early retirement, a career transition, a sabbatical, a year spent starting a business with little initial revenue — these are the windows where your marginal tax rate drops. Converting $50,000 from traditional to Roth in a year where you’re in the 12% bracket costs $6,000 in taxes today. Do that same conversion in a year where you’re in the 24% bracket 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 your next income source kicks in, your taxable income for the year may be lower than it will be for a long time. This is the window.

How to Think About This Decision

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

Run the numbers with your actual situation. A fee-only financial planner charging a flat rate — something like $250 to $500 for a standalone consultation — can model this for you specifically. The Roth conversion decision at rollover is one of the highest-leverage planning moments in someone’s retirement timeline. Don’t sleepwalk past it just because “rollover to traditional IRA” is the path of least resistance.

The Bottom Line

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

The common thread across all five is that the expensive outcome is almost always avoidable with one phone call or one hour of research made before initiating the rollover. Once the distribution is processed, 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. If there’s employer stock or significant assets involved, spend the money on a fee-only advisor for a single session. The cost of getting this right is almost always lower than the cost of getting it wrong.