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Got Old Retirement Accounts? 5 Costly Mistakes to Avoid

Having retirement accounts with previous employers can leave you unsure about what to do with them. Laura reviews your options five costly mistakes to avoid when dealing with your old retirement plans.

By
Laura Adams, MBA,
Episode #565
Got Old Retirement Accounts? 5 Costly Mistakes to Avoid

Sue B. says, “I’ve had multiple jobs in the past few years and still have a different retirement plan from each one. Should I roll them all over into an IRA for better tracking or just keep them in their separate accounts?”

Thanks for your question, Sue! The average American worker will have more than 11 jobs in their lifetimes, according to the Bureau of Labor Statistics. Chances are many will come with a retirement plan, such as a 401(k), a 403(b), or a Thrift Savings Plan (TSP), if you work for the federal government.

But knowing what to do with an old retirement plan when you change jobs can be confusing. In this post, I’ll review your options and cover five costly mistakes to avoid.

5 Costly Mistakes to Avoid With Old Retirement Accounts

  1. Cashing out old account balances. 
  2. Forgetting about old plans. 
  3. Missing the benefits of consolidation. 
  4. Not factoring in your age. 
  5. Doing an indirect rollover.

Before making any moves with your retirement account, make sure you understand some of the biggest missteps and how to avoid them.

1. Cashing out old account balances.

By far, the worst mistake you can make with an old retirement account is cashing it out. So I’m glad that Sue didn’t say this option was on her mind.

Many people get lured into cashing out an old retirement plan because it’s tempting and easy to do. Problem is, cashing out is incredibly expensive. If you’re younger than age 59½, taking a retirement distribution means you must pay income tax, plus an additional 10% early withdrawal penalty.

Here’s an example: Let’s say you have a balance in a traditional account of $50,000 and decide to cash out. If you must pay 40% for federal and state tax, plus an additional 10% penalty, you lose 50%. Your $50,000 retirement balance just shrunk to $25,000 in one fell swoop. That makes me want to cry!

If your distribution is large enough, it could also push you into a higher tax bracket for the year, costing you even more in taxes. In addition, you lose all future growth that your account could have earned.

For instance, if you’re 30 years away from retirement, $50,000 could grow to more than $500,000, assuming an 8% annual return. So requesting a lump sum distribution and shutting down your account could cost hundreds of thousands of dollars over the long run.

Cashing out a Roth account isn’t as harsh because you previously paid tax on your contributions. However, your earnings (but not your original contributions) in the account would still be subject to income tax and a 10% penalty.

2. Forgetting about old plans.

Another major mistake is simply forgetting to do anything with your old retirement accounts. Sue obviously hasn’t fallen prey to this blunder, either.

If your account has less than a minimum, typically $1,000, your employer has the option to cash you out. If you have more, but less than $5,000, your employer can transfer your balance to an IRA.

If your account satisfies a minimum balance then you can leave your money in a previous employer’s plan, but there are several downsides. One is that you can’t make any new contributions to the account after you’re no longer employed there. Another is that you may be charged extra maintenance fees or be prohibited from benefits that employees get, such as taking hardship distributions.

However, if you do leave a retirement account at an old job, you have the same account access. You can manage it any way you like by selling and buying funds from the available menu of investment options. It can continue to grow and you’ll still get nice tax advantages.

If a former employer’s plan has a terrific menu of diversified investments with low fees, leaving your money there may be a good idea. It’s definitely better than cashing out and you can always do a tax-free rollover in the future, which we’ll cover next.

See also: How to Invest Money in Your IRA or 401k Retirement Account

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