Retirement account mistakes that could cost you

A friend recently called to ask about whether to roll over his old retirement account into a new employer’s plan. When I asked about the fund choices in both the old and new plans, it became clear that he had not paid attention to his retirement account for a while.

The interaction was a good nudge for me to warn others who have taken their eye off the ball. Here are five common mistakes to avoid.

WITHDRAWING INSTEAD OF ROLLING OVER During the recession, many were forced to leave their jobs. That triggered a decision: what to do with retirement funds. The wise and prudent thing to do is to roll the funds over to another account. Unfortunately, many chose to cash out plan assets and pay tax and a penalty. It’s what they felt they needed to do to survive.

Plan administrators usually automatically withhold 20 percent of the balance and send that amount to the IRS. In addition to federal and state income tax, investors younger than 59½ who cash out have to pay a 10 percent early withdrawal penalty. The potential result: Cashing out $50,000 in 401(k) savings may leave just $35,000 in cash.

Cash-outs are most prevalent among younger workers, the ones who would benefit most from keeping the money in a tax-deferred retirement account. Regardless of the age, the retirement saver who withdraws plan assets no longer gets the compounded growth the savings would have occurred in the account.

FAILING TO REBALANCE The old “set it and forget it” mentality can be problematic, because it can ensnare you in one of the classic retirement plan mistakes: not rebalancing on a periodic basis (quarterly, biannually or annually). It has gotten easier to complete this task, because a lot of plans now have an auto-rebalance option. A side benefit of using this feature is that it can help take emotions out of the investment process, essentially forcing you to buy low and sell high.

NOT DIVERSIFYING This is especially bad when you own too much company stock. You know that you shouldn’t put too many eggs in one basket. But some participants don’t realize how much overlap they have among their retirement funds.

It’s far more important to diversify among asset classes (stocks, bonds, commodities and cash) than in the total number of funds. Additionally, if your company stock is an option in your plan, limit your exposure to 5 percent of your total investment holdings. Sure, the stock may be awesome now, but do you really need to risk your retirement on the company’s performance? Since many companies match in their stock, it is incumbent on you to keep an eye on your allocation ... or use that auto-rebalance!

CHOOSING HIGH-FEE FUNDS One way to increase your return without risk is to reduce the cost of investing. If your plan offers index funds, you may be able to save for retirement at a fraction of the cost of managed funds. If your plan is filled with expensive funds, gather your co-workers and lobby your employer to add low-cost index funds to your plan.

TAPPING RETIREMENT FUNDS TO PAY DOWN A DEBT Workers sometimes dip into retirement funds to whittle away their outstanding credit card balances and other bills. While the IRS does allow for hardship withdrawals in certain instances, pulling money from retirement accounts should be a last resort, due to the aforementioned fees and taxes. Additionally, many workers who are over 59½ are tempted to use retirement assets to pay down a mortgage as they approach retirement. The biggest risk in doing this is that you may deplete your liquid assets to eliminate a debt on a nonliquid one.

Jill Schlesinger, a certified financial planner, is a CBS News business analyst. She welcomes emailed questions and comments.