Financial advisors are well aware of the tax rules that affect retirement withdrawals, required minimum distributions, Roth conversions and rollovers. Clients, though, can often make major wealth-killing mistakes when managing their retirement savings. 

Such mistakes are becoming increasingly common as Americans find more of their household wealth concentrated in retirement accounts.

A  growing number of individuals are making “fatal errors” in the rollover process, especially as people change jobs more frequently and face tricky decisions about whether to consolidate accounts from past jobs.  Here are some Key mistakes that people can make during the rollover process — potentially robbing them of a substantial portion of their wealth through penalties, excise taxes and fees.

Here are two potential pitfalls to avoid:

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Mistake No. 1: Making Indirect Rollovers

“And by ‘rollovers,’ I mean when you take the money out … and you get a check and roll it over, say, to an IRA. … You have to complete rollovers within 60 days,” 

Our advice is to do only direct transfers from account to account. This approach eliminates the risk of late reinvestment while allowing clients to avoid the uncomfortable experience of “mandatory withholding,” generally at 20% of the rollover amount.

For example, if clients received a $10,000 eligible rollover distribution from their 401(k) plan, their employer must withhold $2,000 from that distribution. If the recipients later decide to roll over the $8,000, but not the $2,000 withheld, they will report $2,000 as taxable income, $8,000 as a nontaxable rollover and $2,000 as taxes paid.

People in this situation must also pay a 10% additional tax on early distributions on the $2,000 — unless they qualify for an exception.

On the other hand, if they decide to roll over the full $10,000, they must contribute $2,000 from other sources. In this case, the clients will report $10,000 as a nontaxable rollover and $2,000 as taxes paid.

Ultimately, if clients roll over the full amount of any eligible rollover distribution they receive — i.e., the actual amount received plus the 20% that was withheld — the entire distribution would be tax-free, and they would avoid the 10% additional tax on early distributions.

It is better in almost all cases to avoid this by undertaking a direct transfer.

“You don’t have to worry about 60 days if you would do a direct transfer,” 

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Mistake No. 2: Making Multiple Rollovers Per Year

The rule states that individuals generally cannot make more than one rollover from the same IRA within a one-year period. A person also cannot make a rollover during this one-year period from the IRA to which the distribution was rolled over.

This framework sounds simple enough, but it continues to trip people up. The penalties for making such mistakes can be very painful.

“It’s not a calendar year. It’s a fiscal year, or 365 days,” “So, some people might say, ‘Well, I know about the once-per-year rollover rule. So, I’m going to roll over some in December, and then January is a new year.’ No. If you do a second rollover within the 365 days, [that’s a violation]. It can’t go in. It would be an excess contribution and result in more penalties.”

We emphasize the appeal of direct transfers, noting that the once-per-year rule doesn’t affect the ability to transfer funds from one IRA trustee directly to another, because this type of transfer isn’t technically a rollover.

Also notable, the once-a-year limit does not apply to rollovers from traditional IRAs to Roth IRA conversions, trustee-to-trustee transfers to another IRA, IRA-to-plan rollovers, plan-to-IRA rollovers and plan-to-plan rollovers.

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