5 Mistakes People Make When Rolling Over a 401k to an IRA

A 401k rollover is the process of moving retirement funds from an employer-sponsored plan into an Individual Retirement Account (IRA) — but 401k rollover mistakes during this transfer can cost you thousands in unnecessary taxes and penalties. According to IRS rollover guidelines, a failed or improper rollover is treated as a taxable distribution, subject to both income tax and a 10% early withdrawal penalty if you are under age 59½.

With Americans holding over $7 trillion in IRA assets, the stakes for getting this transfer right have never been higher. A few procedural errors can permanently shrink your retirement balance.

What Happens If You Miss the 60-Day Rollover Deadline?

Missing the 60-day deadline converts your rollover into a taxable distribution — one of the most expensive 401k rollover mistakes you can make. The IRS requires that indirect rollovers be completed within 60 days of receiving the funds, or the entire amount is treated as ordinary income.

If you are under 59½, the IRS also tacks on a 10% early withdrawal penalty on top of your regular income tax rate. For someone in the 22% tax bracket rolling over $50,000, missing the deadline could mean owing $16,000 or more in taxes and penalties on money you intended to keep invested.

The IRS does grant hardship waivers in limited circumstances — such as a serious illness or a bank error — but these are not guaranteed and require a formal request process. The safest strategy is to never take possession of the funds at all, which leads directly to the next common mistake.

Is an Indirect Rollover Always a 401k Rollover Mistake?

Choosing an indirect rollover instead of a direct transfer is one of the most preventable 401k rollover mistakes. In an indirect rollover, your employer sends you a check — but is legally required to withhold 20% for federal taxes upfront.

That withholding does not disappear. To complete the rollover tax-free, you must deposit 100% of the original distribution — including the withheld 20% — into your IRA within 60 days. That means you must cover the withheld amount out of pocket and wait to recover it as a tax refund.

Why a Direct Trustee-to-Trustee Transfer Eliminates This Risk

A direct rollover sends funds straight from your 401k plan administrator to your new IRA custodian — you never touch the money. According to FINRA’s guidance on 401k rollovers, direct transfers avoid mandatory withholding entirely and carry no 60-day deadline risk. Institutions like Fidelity, Vanguard, and Charles Schwab all support direct transfer requests, typically initiated with a simple form from your new IRA custodian.

Does Rolling Into the Wrong IRA Type Cause Tax Problems?

Rolling a traditional pre-tax 401k into a Roth IRA without planning for the tax bill is one of the most overlooked 401k rollover mistakes. The conversion is legal, but every dollar transferred from a traditional 401k to a Roth IRA is treated as taxable income in the year of the conversion.

For a $200,000 rollover, that could push you into a significantly higher tax bracket for the year — potentially costing tens of thousands of dollars in immediate taxes. If your goal is tax-free growth in retirement, a Roth conversion can make sense, but it requires careful tax planning first. If you are unsure which account type fits your retirement timeline, our guide on Traditional IRA vs Roth IRA for late starters breaks down the tradeoffs clearly.

Why Do Required Minimum Distributions Trip Up 401k Rollovers?

Attempting to roll over a Required Minimum Distribution (RMD) is one of the lesser-known but costly 401k rollover mistakes. If you are age 73 or older, the IRS requires you to withdraw a minimum amount from your 401k each year — and that RMD amount cannot be rolled over into an IRA.

According to IRS RMD rules, rolling over an RMD is treated as an excess contribution to the IRA, which triggers a 6% excise tax on the excess amount for each year it remains in the account. You must take your RMD first, then roll over only the remaining balance.

This rule also applies in the year you leave your employer. If you separate from service in the same year you turn 73, you must calculate and withdraw the RMD for that year before initiating any rollover. For those still building their retirement strategy later in life, our article on how to start saving for retirement in your 40s provides useful context on compounding timelines that affect these calculations.

Are You Ignoring Hidden Fees When Choosing Your Rollover IRA?

Choosing an IRA custodian without comparing fees is a quiet but compounding 401k rollover mistake. A difference of just 0.50% in annual fees on a $100,000 rollover can cost over $30,000 in lost growth over 20 years, according to the Department of Labor’s guidance on retirement plan fees.

Many people default to opening an IRA at the same bank where they hold a checking account — without comparing expense ratios, account maintenance fees, or investment selection. Discount brokerages like Fidelity, Vanguard, and Schwab offer $0 commission trades and broad access to low-cost index funds, which can significantly outperform actively managed alternatives over time. If you want to understand how fund selection impacts long-term wealth building, our breakdown of index funds vs ETFs is a useful next step.

Beyond fees, confirm that your new IRA custodian accepts rollovers from employer plans before initiating the transfer. Not all IRA providers have the same account-opening requirements or processing timelines, and delays can create unintended complications with plan administrators.

Frequently Asked Questions

How long do I have to roll over a 401k after leaving a job?

If you take an indirect rollover, you have 60 days from the date you receive the funds to deposit them into an IRA. For a direct rollover, there is no time limit — your plan administrator transfers funds directly to the new custodian, and the 60-day rule does not apply. Most financial advisors recommend initiating a direct rollover as soon as your new IRA is open.

What is the one-rollover-per-year rule?

The IRS limits individuals to one indirect IRA-to-IRA rollover per 12-month period, regardless of how many IRA accounts you have. Violating this rule causes the second rollover to be treated as a taxable distribution. Direct trustee-to-trustee transfers are not subject to this limitation and can be done as many times as needed.

Can I roll over a 401k while still employed?

Most employer plans do not allow rollovers while you are still actively employed, though some plans permit in-service distributions after age 59½. You should check your specific plan documents or contact your plan administrator to confirm whether an in-service rollover is available. This is less common in standard 401k plans but more frequent in pension or profit-sharing arrangements.

Do 401k rollover mistakes trigger an audit?

An improperly executed rollover — such as missing the 60-day deadline or rolling over an RMD — creates a discrepancy between your 1099-R and your tax return, which can flag your return for IRS review. It is not an automatic audit trigger, but the IRS cross-references Form 5498 (issued by IRA custodians) with Form 1099-R to verify rollover completions. Accurate reporting and working with a tax professional reduces this risk significantly.

What happens to my 401k if I do not roll it over?

If your vested balance exceeds $7,000, your former employer must allow you to leave the funds in the plan. Balances below $1,000 can be cashed out automatically, while balances between $1,000 and $7,000 may be rolled into an IRA by the plan administrator. Leaving funds in a former employer’s plan is sometimes a valid option if the plan offers exceptionally low-cost institutional funds unavailable elsewhere.

Is it better to roll a 401k into a traditional IRA or Roth IRA?

For most people, rolling a pre-tax 401k into a traditional IRA is the default choice because it is tax-neutral — no tax is owed at the time of transfer. A Roth IRA rollover makes sense if you expect your tax rate in retirement to be higher than it is today, but requires paying income tax on the full converted amount in the year of transfer. A fee-only financial advisor or CPA can model both scenarios using your specific income projections.