Don’t Make These 401k Rollover Mistakes

I am a big fan of 401(k) rollovers into an Individual Retirement Account (IRA) when you leave a job. One of the advantages is that if your 401(k) doesn’t offer low-cost index mutual funds, when you do a rollover to an Individual Retirement Account (IRA) at a brokerage you choose, you will have access to both low-cost index mutual funds and exchange-traded funds (ETFs).

But I want to make sure that you are making the most of your 401(k) rollover.

Quite often when you move money from a 401(k) into an IRA at a brokerage firm, the back-office folks at the 401(k) will first convert your account into cash and then transfer the cash to the firm where you have your rollover IRA.

And it seems that plenty of people just keep their rollover retirement IRA in cash. A recent report says that 30% of people who rollover money from a 401(k) into an IRA leave the money entirely in cash for at least seven years.

That can lead to two potentially costly mistakes. If you have done a 401(k)-to-IRA rollover, or are considering one, please make sure you are making the most of your account.

Do you mean to have that much in cash?

Those of you who have read my Ultimate Retirement Guide for 50+ know that I recommend having at least two years of living expenses set aside in cash (in addition to an emergency savings fund) when you are retired. If you are near or in retirement and your rollover IRA is for this extra cash cushion, that’s fine. But if the rollover account value is more than you need to keep in cash, or you are not yet near retirement, I want you to consider if keeping the entire account in cash is your best move.

Cash, especially when you are retired, is necessary and valuable. But over a 25 to 30 year retirement, it is likely you may also benefit from owning stocks and bonds as well. Over the long-term, stocks are what can provide returns that are better than the rate of inflation. Cash typically doesn’t beat inflation or provide a big enough inflation cushion. 

And if you have years, or decades until retirement, you definitely need your portfolio invested with an eye on earning inflation-beating gains over the long term.  That’s an argument for owning stocks, not cash.

If you are near or in retirement and aren’t sure how much of your retirement money to invest (rather than keep in cash), I have lots of advice in The Ultimate Retirement Guide for 50+. And regardless of your age, it’s likely that the brokerage where you moved your money has free online tools you can use to help you figure out the right asset allocation for your retirement money.

Are you earning as much as possible on your cash at a discount brokerage? 

Okay, now if you have made a carefully considered strategic decision to have retirement money invested in cash, I want to make sure you are earning a solid rate of interest on that cash.

Please don’t assume the company handling your rollover IRA will automatically put you in a cash account that earns the going rate for safe short-term assets.

What you need to check is that your “cash” is in fact invested in a money market mutual fund (MMMF). My preference is a money market mutual fund with the name “Treasury” or “Federal” in it. This means it invests in U.S. Treasury or U.S. agency securities. While no MMMF offers federal deposit insurance (only certain accounts that are offered at federally insured banks and credit unions provide that protection), an MMMF operates very much like a safe savings account, and if you choose an MMMF that invests only in government issues you have an important layer of safety. 

As I write this, federal money market mutual funds at low-cost discount brokerages have yields in the range of 4.7% to 5%. If you aren’t earning that much, you may have been “defaulted” into a different type of account. With a few clicks, you should be able to easily transfer (exchange) your cash holdings into a higher-yielding government-focused money market mutual fund.