5 Must-Know Ways to Avoid Losing Money, What to Do with an Old 401(k), the "Pro-Rata Rule" Explained, and More

Read Time: 4-minutes

Happy Saturday,

Here is this week’s edition of 6-Point Saturday — financial insights to help you make smarter money decisions.

Table of Contents*

• Point #1 — Short Story: The Hardest Money Skill

• Point #2 — 5 Ways to Avoid Losing Money

• Point #3 — “What should I do with my old 401(k)?”

• Point #4 — The “Pro-Rata” Rule Explained

• Point #5 — Quotes of the Week

• Point #6 — My Question of the Week

*Clickable in the online version. 

Point #1 — Short Story: The Hardest Money Skill

The Wall Street Journal columnist Jason Zweig worked with Nobel Prize winner Daniel Kahneman to create the New York Times bestselling book: “Thinking, Fast and Slow.” Zweig on what he learned during the experience:

Wow, that’s commitment. Perhaps even a seemingly superhuman ability to scrap everything in a project.

Why is this so difficult? Because we tend to get so tied to our previous “inputs”: time, money, energy and resources.

So, the idea of “scrapping” everything to start fresh seems incredibly painful.

But it can also be the shortest path to our ideal destination.

This idea, Sunk Cost, means a cost that has already been incurred and is no longer recoverable.

While Kahneman applied it to his writing, sunk costs can quietly trap us every day in our finances and careers:

• Holding on to an investment that performed poorly because selling locks in a loss

• Staying in a costly home because you’ve already invested so much

• Paying for a budgeting app that you can’t seem to use consistently

• A project at work that underperforms after a significant initial investment

• Staying in a career that drains you because “I’ve already invested 10 years here”

We often know the best choice in these situations is to cut our losses.

But it can be so hard to actually do.

Because, for one, we tend to view this as “accepting defeat”…And most people hate losing!

So, let’s look at 5 ways we can overcome the mental obstacles to eliminate sunk costs (without needing to be superhuman) in the next Point…

Point #2 — 5 Ways to Avoid Losing Money

1. Ask A Different (Better) Question: The first way to “stop throwing good money after bad” is a simple question:

This question reframes your decision around future value, so you can detach yourself from past “losses.”

2. Set “Pre-Commitment” Rules: Next, you can set some “Pre-Commitment” rules. These are rules that you set ahead of time to reduce emotional attachment in the heat of the moment. For example, before you make an investment, you could decide that you will sell the stock if it falls 20%. To take it further, you could set what’s called a “Limit Order,” or a trade instruction that automates this decision to sell.

3. Consider the “Outside View”: Another exercise is what Kahneman describes as considering the “Outside View” of any project. The Outside View is how well your type of project has fared statistically. In other words, how people in your situation have performed in the past. For example, most beginner stock investors aren’t that great at picking individual stocks. So, rather than overly focus on your strengths—the Inside View—you consider the general odds of success. This can help you shift from focusing on any past losses to your future potential.

4. Reframe Sunk Costs as Valuable: By labelling past costs as “tuition,” you understand that everything in the past can be valuable. While you might be out some money from any given project, you more than likely acquired experiences, knowledge, and skills that will be valuable assets as you go forward.

5. Use Accountability Mechanisms: You can use checklists to add discipline to your decisions or set up an accountability system. Sharing your decisions with someone else or journaling about them so you have some way to be held accountable helps you learn from your decisions over time.

Point #3 — “What should I do with my old 401(k)?”

This Reddit user asks what to do with an old 403(b). 403(b)’s are largely identical to 401(k)’s—the main difference being the type of employer that offers them (403(b)s usually from public schools and nonprofits, 401(k)s by private-sector employers).

Since 401(k)s are more common, I’ll use that term below. The decision factors generally apply to 403(b)s as well.

Your options:

1. Keep it in your previous employer’s plan

2. Roll it over to your new employer’s plan

3. Roll it over to a Traditional IRA

4. Cash out (Costly: taxes and penalties if you’re under age 59 1/2)

Factors to consider:

The best choice depends on your goals, but here are some key factors to consider:

1. Compare Investment Options: Compare what funds you have available through your old 401(k) and new options. Your investment “menus” with 401(k)s are typically limited, while a Traditional IRA allows you to invest in “anything.”

2. Evaluate Plan Fees: This includes both investment fees and plan administration fees. Of course, lower is generally better.

3. Consider Ease of Use & Service: Can you easily check your plan information and make updates to your plan? Some interfaces are a bit more “clunky” to use. Also, consider the level of customer service you’ve received resolving any prior issues.

4. Don’t Underestimate Simplicity: There’s value in simplicity. Maintaining fewer accounts, by rolling over old 401(k)s to a single Traditional IRA, means a clearer financial picture and updating things like your address and beneficiary designations is easier.

5. Mind the “Rule of 55”: If you’re planning on retiring early, the “Rule of 55” lets you tap 401(k) funds at age 55 without the 10% penalty. This is not allowed for funds in a Traditional IRA.

6. Understand Creditor Protection: 401(k)s under ERISA regulations are protected in case you are sued, while IRAs have more limited state-level protections.

7. Know “Backdoor Roth” Rules: If you are above the income limit to make a Roth IRA contribution ($150,000 in modified adjustable gross income for Single filers, $236,000 if you’re filing as Married Filing Jointly for tax year 2025), a Backdoor Roth is an IRS allowed way to still make contributions (essentially, you contribute to a Traditional IRA and immediately convert funds to a Roth IRA). However, you must be mindful of what’s called the “Pro-Rata Rule”…which we’ll explore in the next Point…

Point #4 — The “Pro-Rata” Rule Explained

The IRS’s “Pro-Rata” rule treats all your IRAs as one “big bucket” when you do conversions. Let’s look at an example;

Meet Sarah, a software engineer earning $225,000, filing her taxes as single. Her income is too high for direct Roth IRA contributions. She's considering what to do with her $75,000 old 401(k) when she switches jobs.

Scenario 1: Roll to Traditional IRA

If Sarah rolls that $75,000 into a Traditional IRA, she triggers the “Pro-Rata” rule. If she tries the Backdoor Roth (making a $7,000 non-deductible contribution to a Traditional IRA, then converting to Roth), the IRS sees her total Traditional IRA balance as $82,000. Only 8.5% of her conversion would be tax-free ($7k / $82k) – the rest gets hit with taxes, making the Backdoor Roth strategy inefficient.

Scenario 2: Keep in a 401(k)

If Sarah either leaves the money in her old 401(k) or rolls it to her new employer's plan, the Pro-Rata rule doesn’t apply. Now, when she does the Backdoor Roth, her full $7,000 nondeductible contribution converts tax-free.

The bottom line: Keeping retirement funds in 401(k) plans preserves the Backdoor Roth strategy for high earners.

Point #5 — Quotes of the Week

Continuing the “avoiding Sunk Costs” theme, which of these is your favorite?

Point #6 — My Question of the Week

Reply to let me know! I read every response.

Thanks for reading — I hope you found a helpful idea or two.

I’ll see you next Saturday with more.

Have a great weekend,

Benjamin Daniel, CFP®
Founder, Money Wisdom

P.S. Want to take control of your money (and stop stressing)? Here are 2 ways I can help:

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Disclaimer:

This material is not investment or tax advice. No responsibility for loss occasioned to any person or corporate body acting or refraining to act as a result of reading this material can be accepted by the publisher.

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