Most Common 401k Rollover Mistakes and How To Avoid Them

However, executing a 401(k) rollover incorrectly can result in avoidable taxes, penalties, and lost investment growth.

This guide examines the most common 401(k) rollover mistakes, their underlying causes, and the additional considerations that apply to internationally mobile individuals.

It also outlines practical strategies to reduce these risks, safeguard retirement capital, and support long-term financial security.

What Is a 401(k) Rollover?

A 401(k) rollover involves transferring funds from a 401(k) retirement plan to another eligible retirement account. The main purpose of a rollover for expats is to consolidate retirement savings from one or multiple 401(k)s into an account that allows individual contributions, like an individual retirement account (IRA).

Since you must open and fund IRAs individually, these accounts provide more control over your contributions, investments, and sometimes withdrawals, depending on your chosen account.

US expats, residents, and citizens with a 401(k) typically choose to rollover their 401(k) funds to one of the following two accounts:

1. Traditional IRAs: Like traditional 401(k)s, these accounts accept pre-tax contributions, meaning direct rollovers to traditional IRAs are tax-free if done accurately since you’re moving funds between accounts with the same tax treatment.
2. Roth IRAs: Like Roth 401(k)s, Roth IRAs are funded with after-tax contributions. A direct rollover from a Roth 401(k) to a Roth IRA is generally not taxable, as the funds are already after-tax. However, a rollover from a traditional (pre-tax) 401(k) to a Roth IRA is called a Roth conversion, and the full amount is taxable as ordinary income in the year of transfer.

Special Considerations

• If your 401(k) includes after-tax (non-Roth) contributions, you may be able to roll the after-tax basis to a Roth IRA tax-free and direct any earnings to a traditional IRA, or pay tax if converting the earnings.
• In a direct rollover (trustee-to-trustee transfer), funds move directly between accounts and avoid the 20% mandatory withholding tax. In an indirect rollover, the plan pays you the funds (often by cheque payable to you), and 20% is withheld for tax; you must redeposit the full rollover amount, including the withheld portion, within 60 days to avoid tax and penalties.

What Are the Most Frequent 401(k) Rollover Mistakes?

While a 401(k) rollover is typically a straightforward process, failing to adhere to rollover rules may expose you to significant tax penalties, reducing your retirement savings. To avoid any unexpected tax liabilities during the rollover process, take into account the following 401(k) rollover mistakes:

1. Choosing an incorrect type of rollover
2. Transferring savings to an ineligible account
3. Missing the 60-day rollover deadline
4. Rolling over at the wrong time
5. Not investing rollover funds

Choosing an Incorrect Type of Rollover

There are two common types of 401(k) rollovers:

1. Direct rollover: Includes transferring retirement savings from one account to another directly.
2. Indirect rollover: Involves a 401(k) provider paying the rollover funds to you as a cheque. You then deposit the funds into an IRA within 60 days of receiving them.

Opting for an indirect rollover is a common mistake because it entails a 20% mandatory withholding tax.

For instance, if you decide to roll over $20,000 to an IRA, you will receive a cheque for $16,000, but will still be required to deposit the full rollover amount, including the withheld 20%. If you do so, you will reclaim the withheld amount when filing an annual tax return. Otherwise, the 20% you failed to deposit will be subject to income tax and a 10% early withdrawal penalty if you’re under the retirement age of 59 ½.

Always opt for a direct rollover if your 401(k) provider allows it. A direct rollover is a straightforward and tax-free process as long as you’re moving funds between accounts with the same tax treatment.

Transferring Savings to an Ineligible Account

Before you roll over your 401(k), you must choose a retirement account that is eligible to accept the transfer. The IRS permits transfers between most types of 401(k)s and IRAs, with certain exceptions, such as Roth 401(k) rollovers to traditional IRAs.

To maximise savings and minimise tax liabilities during a 401(k) rollover, ensure you move 401(k) funds to an account with the same tax treatment wherever possible. The following combinations should generally be avoided or require careful tax planning:

Missing the 60-Day Rollover Deadline

If your 401(k) administrator does not allow direct rollovers and you must transfer retirement savings indirectly, make sure you do so within 60 days of receiving the rollover cheque.

If you do not finalise the process in 60 days, the rollover amount will be subject to income tax at your marginal tax rate. You may also be liable for a 10% tax penalty if you haven’t reached retirement age because the rollover will be considered an early withdrawal from your 401(k).

The IRS may allow self-certification for a late rollover if you meet certain qualifying conditions.

Rolling Over at the Wrong Time

Timing your 401(k) rollover is crucial for reducing tax liability and increasing your retirement savings. If you initiate a rollover prematurely or delay it for a long period, you may not be able to transfer your 401(k).

For instance, you can’t transfer your entire 401(k) balance until the vesting period ends. Employer contributions vest under ERISA schedules—either three-year cliff or six-year graded—though some plans (for example, safe harbour) are immediately vested. Verify your plan’s vesting schedule before rolling over.

Many plans also permit in-service distributions or rollovers while you are still employed, typically from age 59½, but this depends on your plan’s rules. Always check the plan document and request a direct trustee-to-trustee transfer where possible.

Delaying a rollover for too long may also prevent you from executing it. From age 73 (rising to 75 for those reaching age 74 after 31 December 2032), most tax-deferred accounts require required minimum distributions (RMDs). The RMD amount cannot be rolled over. From 2024, Roth 401(k)s no longer require RMDs during the owner’s lifetime.

The timing of your 401(k) rollover is especially important if you plan to transfer funds to a Roth IRA. Since this type of rollover is taxable when moving pre-tax funds, transferring a 401(k) before retirement (while you are likely in a higher tax bracket) can reduce your pension pot.

A Roth conversion itself does not trigger the 10% early-withdrawal penalty, but withdrawing converted amounts within five years can.

Additionally, you can only roll over an active 401(k) if your employer’s plan permits it; otherwise, you must wait until you separate from service.

Not Investing Rollover Funds

While your retirement funds are in a 401(k), they may be automatically invested in assets your employer or plan administrator chooses. However, unlike 401(k)s, IRAs require you to select and manage your investments actively, either on your own or with the help of a financial adviser.

If you don’t invest your rollover IRA funds, they will likely remain in a money market fund. These funds allocate your contributions to low-risk assets that yield minimal returns. Over time, this can hinder the growth of your retirement savings as you’ll fail to capitalise on compounded growth provided by assets like stocks, bonds, and mutual funds.

How US Expats Can Avoid Rollover Mistakes Abroad

Rolling over a 401(k) while living overseas introduces additional risks and regulatory complexities for US expats. The IRS still treats you as a US tax resident on worldwide income, but foreign tax agencies may not align with US retirement account definitions, creating unexpected tax burdens.

Double Taxation Risk

Many countries do not recognise US IRAs or Roth IRAs as tax-exempt vehicles. Even if your rollover is tax-free in the US, your host country may view it as a taxable event or deny tax deferral on subsequent earnings.

FATCA and FBAR Reporting

US-based IRAs and 401(k)s are not themselves reported on the Foreign Bank Account Report (FBAR). However, FBAR obligations may arise if you personally hold foreign financial accounts connected to your retirement strategy.

FATCA reporting is generally handled by US custodians, but large cross-border transfers can still prompt scrutiny from foreign tax authorities.

Currency Conversion Timing

US tax rules assess the rollover using the USD value on the distribution date, while some foreign tax agencies calculate taxable value using local currency on receipt. This can create:

• FX risk during currency conversion.
• Variance in taxable value reported in both countries.
• Potential mismatches between US and foreign tax years, affecting credit claims.

Residency and Rollover Eligibility

Some plan administrators or IRA custodians may restrict rollovers or new account openings for non-US residents due to compliance concerns. Expats should verify that:

• Rollovers from overseas addresses are permitted.
• The IRA can be accessed and managed while abroad.
• Future contributions or withdrawals won’t be blocked or taxed unexpectedly.

To navigate these complexities, US expats should consult a qualified cross-border financial adviser before initiating a rollover.

A specialist can evaluate your tax position in both jurisdictions, confirm account eligibility while living overseas, and structure the rollover to minimise compliance risks and tax exposure.

Titan Wealth International’s expat advisers offer tailored 401(k) rollover assessments and strategic guidance to help you safeguard your retirement savings while optimising your global financial position.

How To Avoid 401(k) Rollover Mistakes

You can avoid making costly 401(k) rollover mistakes by implementing the following best practices:

1. Match your rollover account to your contribution type.
2. Review your circumstances to find the optimal rollover time.
3. Evaluate your investment goals.
4. Seek professional guidance.

Match Your Rollover Account to Your Contribution Type

Choosing an account that accepts the same type of contributions as your 401(k) ensures you avoid unnecessary tax liabilities.

• For a traditional 401(k), consider rolling to a traditional IRA. Both are funded with pre-tax dollars, so a correctly executed rollover will be tax-free.
• The same applies to transfers between two traditional 401(k)s.
• Rollovers between Roth accounts (e.g. Roth 401(k) to Roth IRA) generally do not trigger tax consequences, as the funds have already been taxed.

Review Your Circumstances To Find the Optimal Rollover Time

The timing of a 401(k) rollover can significantly affect both your tax liability and the value of your retirement savings.

Acting too early may trigger unnecessary tax charges, while waiting too long could prevent you from rolling over funds altogether.

Careful planning ensures you capture the full benefit of the transfer and avoid unnecessary penalties.

To avoid common rollover timing mistakes:

• Ensure employer contributions are fully vested. Under ERISA, vesting follows either a three-year cliff or a six-year graded schedule, unless the plan provides immediate vesting (e.g. safe harbour plans).
• Execute the rollover before reaching age 73 (or 75 for those reaching 74 after 31 December 2032), when required minimum distributions (RMDs) must begin. RMD amounts cannot be rolled over and must be taken before any rollover that year.

For a 401(k) conversion to a Roth IRA, the following timeframes may be most suitable for minimising tax liability:

Evaluate Your Investment Goals

Prior to initiating the rollover, assess your financial goals and develop an investment strategy that fits your risk tolerance.

Defining an investment plan before transferring your 401(k) will ensure your rollover funds are actively invested rather than remaining in low-yield money market funds.

IRAs typically provide a wider range of investment opportunities than 401(k)s. If your goal is to generate high returns to accelerate the growth of your retirement savings, you may consider investing in assets like:

• Stocks
• Real estate
• Exchange-traded funds (ETFs)

If you prefer low-risk assets that provide more stability and lower returns, IRAs also offer access to bonds and certificates of deposit.

Seek Professional Guidance

Consulting a financial adviser before, during, and after a 401(k) rollover can help you avoid all the abovementioned mistakes. A financial adviser will ensure you minimise tax liabilities and maximise the growth of your pension fund by providing guidance in the following areas:

• Choosing the correct type of retirement account for a 401(k) rollover based on the type of contributions your 401(k) receives.
• Guiding you through a direct rollover process or ensuring you adhere to the rules of an indirect rollover, avoiding the penalties associated with missing the 60-day deadline and the mandatory withholding tax
• Advising you on the optimal time to do a 401(k) rollover based on your financial circumstances and age-related factors
• Identify advanced strategies, such as using the one-per-12-month rule effectively or handling Net Unrealized Appreciation (NUA) on employer stock before rolling over
• Build an investment strategy aligned to your retirement goals and international tax position