Avoiding the “Hierarchy Trap” in Your 401(k)

When markets get rocky, even savvy investors can be caught off guard, not just by performance swings, but by the way their retirement plans handle withdrawals.

One of the lesser-known pitfalls? Something we call the "hierarchy trap."

What Is the Hierarchy Trap?

Most 401(k) and retirement plans have rules about which investments are sold when you take money out. Ideally, you'd get to directly choose which funds to tap, or the plan might pull money out pro rata (meaning proportionally from all your investments).

However, some plans use a hierarchy-based system instead. That means withdrawals are pulled in a specific order, usually starting with the most conservative or most liquid holdings, such as money market funds.

On paper, this can be a reasonable approach. The idea is to preserve the potential for growth by leaving your stock-based investments intact. But here’s the problem: if you’re intentionally trying to reduce stock exposure, the hierarchy system can work against you, pulling from the very funds you were hoping to leave untouched.

Even worse, many plans don’t clearly disclose these rules in participant summaries. You might not know how your money will be pulled until it’s too late.

What You Can Do

To steer clear of the hierarchy trap, take these proactive steps:

Ask Questions: Before making any withdrawals, check with your 401(k) plan administrator. Ask if your plan uses an automatic fund hierarchy and request details on how it works.
Consider a Pre-Move Reallocation: If you want to reduce your exposure to stocks, consider reallocating from equity funds into whatever fund sits at the top of the withdrawal hierarchy, before making a redemption.
Keep Long-Term Focus: Market volatility can tempt investors into quick decisions. Remember: retirement accounts are designed for the long haul. Don’t let short-term swings drive long-term mistakes.

We’re Here to Help

Managing a 401(k), especially if you have multiple accounts from previous jobs, can get complicated fast. Different plans carry different rules and different risks.

That’s why Hanover offers a 401(k) aggregation service to help you bring it all together. We’ll help you make sense of your various retirement plans, optimize allocations, and coordinate smart, tax-efficient strategies for your future.

Have questions? Contact us today. Because when it comes to retirement, clarity is power, and confidence starts with a plan.