“Mistake #2. Rolling Over a 401(k) Plan Laden with Company Stock. Savvy investors often assume that if they leave a former employer, their best bet is to roll the money over into an IRA as soon as possible. Not only does moving the money into an IRA enable them to circumvent the extra layer of administrative costs that may accompany the 401 (k), but an IRA also gives them the ability to invest in a much wider range of investment options that are typically found on a 401(k) menu.
“However, a rollover to an IRA isn’t always the best option, especially if a 401(k) contains a sizable stake in company stock that was amassed with the employee’s own pretax contributions and employer-matching contributions. In that instance, it may be better to leave the money behind in the 401(k) and take distributions directly from the account. By leaving the money in place, the investor can take advantage of a special provision in the tax code that enables him to pay ordinary income tax on the cost basis in the shares, but long-term capital gains tax on the appreciation in the shares over and above the cost basis. By rolling the money into an IRA, the investor would owe income tax on the whole amount of the distribution.
“Of course, rolling a company-stock-laden 401(k) into an IRA isn’t always a mistake. If leaving the assets in place in the 401(k) means a woefully underdiversified portfolio and the investor won’t be tapping the 401(k) for many years, rolling the assets into the IRA and reducing the company-specific risk is probably the right move.”