Millions of American workers made a costly mistake by rolling money from their 401(k) plan into an individual retirement account, or IRA, according to new data.
About 28% of savers who rolled over their retirement funds into an IRA in 2015 didn’t roll over the money (leaving it as cash in the new account) for at least seven years, investment firm Vanguard found in an analysis published Monday.
“Cash is the default investment choice for contributions to individual retirement accounts, even though it is generally prohibited as a default investment choice in 401(k) plans,” the researchers wrote. “Unless individuals voluntarily invest IRA assets, they tend to remain in cash indefinitely.”
Vanguard estimated that the mistake costs retirement savers a total of $172 billion per year in retirement wealth. For each person, that amounts to more than $130,000 in lost wealth by the time a person reaches retirement age.
It’s a widespread problem: IRS data shows that about 5 million Americans roll over their retirement savings into IRAs each year. Of those, a Vanguard study suggests that at least 1.4 million aren’t rolling over their contributions.
Refinancing mistakes are worse for younger investors
Many workers choose to transfer their retirement savings from their former employer’s 401(k) plan into an IRA when they leave their job, known as a 401(k) rollover. While this is not usually required (workers can have as many 401(k) plans as they want), it is a popular way to consolidate retirement accounts and have more control over them.
According to the Tax Policy Center, a nonpartisan think tank, nearly 65 million Americans own individual retirement accounts (IRAs). While many more Americans have employer-sponsored plans, such as 401(k)s or 403(b)s, collective IRA balances now dwarf workplace retirement plans.
According to Vanguard, retirement savers have more than $13 trillion in individual retirement accounts (IRAs), about $3 trillion more than employer-sponsored plans. One of the main reasons is rollover: Each year, the majority of IRA contributions are rolled over funds (88% in 2020) rather than direct contributions.
But sometimes people don’t take the final step to maximize their money by rolling over those 401(k) funds. Vanguard’s study suggests that a significant portion of the $13 trillion in IRA accounts is allocated as cash and therefore not generating crucial stock market returns.
The study also found that some people are more likely than others to accidentally leave their IRA rollover contribution behind. Age, gender and wealth were important factors.
For example, investors in their 20s were much more likely than their elders to have their IRA balances in cash. In fact, most of them were found to have not invested their balances after seven years. The same was true for account holders with smaller balances, $5,000 or less. In contrast, older, wealthier investors typically reallocated the cash within a few months of the transfer.
Regardless of age or wealth, Vanguard found that women were “significantly more likely” than men to hold their transfer balances in cash.
Although the financial firm’s analysis focused on rollovers, overlooking this crucial step is a common problem in IRA accounts. In recent years, many young investors have taken to social media to share their investment mistakes in an attempt to prevent others from making the same financial folly.
“Do you want to hear something that makes you feel better about yourself?” TikToker Kayla Caneat asked in a 2022 video that has racked up more than 2 million views. She explains that she made monthly contributions to a Roth IRA for more than two years before realizing the money wasn’t invested.
“I never bought a single share,” he said, staring into the camera. “I thought it was automatic.”
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