The Old 401(k) Habit That Trips Up Retirees at Tax Time

Many workers approaching retirement focus on how much they have saved and pay little attention to where that money sits. A widely cited estimate says about 80% of workers make the same mistake: they leave balances in old 401(k) plans from former employers and never bring them together. The result is more than clutter. Each account carries its own fees, investment menu and paperwork, and a small balance from a job held decades ago is easy to forget entirely.

The tax consequences tend to show up later. Money left in several tax-deferred accounts keeps growing, and once a retiree reaches the age for required minimum distributions, or RMDs, each plan has to be handled on its own terms. Under current rules, RMDs generally start at age 73 for people born from 1951 through 1959, and at 75 for those born in 1960 or later. Withdrawals from 401(k) plans are calculated separately for each plan, which is more work than many people expect. Miss an RMD and the IRS can impose an excise tax on the shortfall, although the rate was reduced by recent legislation and can be lower if the mistake is corrected quickly.

Withdrawals also count as ordinary income. Pulling required amounts from several accounts in the same year can push a retiree into a higher tax bracket, increase the portion of Social Security benefits that gets taxed, and raise Medicare premiums through income-related surcharges. None of these effects is unusual, but they are easier to control when the accounts are organized before withdrawals begin.

A practical first step is to list every old plan, with its balance, fees and whether it allows withdrawals or rollovers. Many people then consolidate into a single rollover IRA or, where the plan allows, into their current employer's 401(k). The right move depends on costs, investment options and whether a plan offers protections that an IRA may not, so comparing those details matters. A direct rollover, where the money moves straight from one institution to another, avoids the mandatory withholding that applies when the check is made out to you.

The 80% figure is an estimate, and it is worth checking how it was measured before treating it as a precise count. The underlying problem, though, is familiar to plan administrators and financial planners alike: retirement savings that are spread out are harder to track, harder to withdraw from efficiently and easier to lose. For anyone nearing retirement, a short review of old accounts now can prevent a tangle of tax forms and deadlines later. A fee-only financial planner or tax professional can help work through the details for a specific situation.