Workers lose billions of dollars in investment gains by withdrawing their retirement savings from the stock market after changing jobs, often unintentionally.
When people roll over their old 401(k) plan balances into an individual retirement account, the money is typically held in cash until they select new investments. Many never do so, according to new research from Vanguard Group. Nearly a third of those who rolled over savings into IRAs at Vanguard in 2015 still had the balance in cash seven years later.
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Americans with cash-rich IRAs give up more than $172 billion a year in retirement wealth they could have generated by investing in stocks and bonds, the Vanguard study estimates.
The mistake is common and costly, especially for younger workers who are used to having their savings automatically invested in company plans. They risk losing years of potential earnings, which accumulate over decades and build wealth for retirement.
The issue is also important for older savers, who tend to need some exposure to stocks to ensure their money lasts, financial advisers said.
The huge sums of cash being unintentionally stashed away are a growing concern since individual retirement accounts (IRAs) have become the dominant way Americans stash their retirement savings, said Fiona Greig, global director of investor research and policy at Vanguard and co-author of the study. IRAs hold $14.3 trillion in assets, compared with $11.1 trillion for 401(k)-type plans, according to the Investment Company Institute, the industry’s trade group.
Brie Pio, a financial advisor in Rockport, Maine, said a couple who hired her in 2021 had rolled over $400,000 from a 401(k) plan into an IRA the year before. It took them a while to realize the money was in cash.
“They couldn’t understand why they weren’t making money when the stock market was showing high returns,” said Pio, who estimated the couple lost about $100,000 by missing out on the rally.
Charge
There are several options for managing your retirement savings when you leave a job. You can keep your 401(k) balance at your old company, roll the money over to a new employer’s 401(k) plan, or roll it over to an IRA instead.
An IRA gives savers more options about where to invest their money, but that money is typically not automatically invested in the market.
When you roll over your 401(k) account to an IRA, the company that administers the 401(k) often sells its holdings and then moves the cash to your IRA.
While rollovers make up a significant portion of IRA assets, some people make annual contributions. Among investors who contributed to an IRA in 2022, more than half held cash for at least 12 months, according to the Vanguard study.
Some account owners put off making decisions about where to put money because they are overwhelmed by the thousands of investment options IRAs offer, said Andy Reed, head of investor behavior research at Vanguard and co-author of the study.
Others mistakenly assume that the company that acts as custodian of their IRA, such as Vanguard or Fidelity Investments, will automatically invest their savings for them, as many 401(k) plans do, Reed said.
Without reminders to take money out of cash, “a lot of IRA investors would stay in cash forever,” he said.
In a recent survey of more than 500 Vanguard IRA clients who completed a rollover in 2023 but still had cash in June, 68% didn’t know how their IRA money was invested.
Missing something
Since the Federal Reserve started raising interest rates in 2022, cash-like investments have gotten a boost. Money market funds now pay around 5% annual interest, meaning cash returns aren’t as bad as they were in 2021, when they were close to zero.
Since 1926, large-cap U.S. stocks have gained an annualized 7.19% after adjusting for inflation, versus 0.31% for cash, according to Morningstar Direct.
Laura Bovard, a 33-year-old nurse from Cincinnati, said she has lost thousands of dollars in earnings because her IRA has been sitting in cash since 2016.
A former employer rolled her pension into an individual retirement account (IRA) after she left her job, something companies can do with pensions and 401(k) accounts when the balance is between $1,000 and $7,000. Bovard said she didn’t know about the IRA until recently, when she received a statement.
“It’s not even at a high level–“It’s a high-yield money market fund. Even now it’s earning minimal interest,” said Bovard, who is rolling the money into his current 401(k)-style plan.
The $3,200 balance would be more than double if the IRA had been invested in stocks over the past eight years, according to an estimate by Bovard’s husband, John Bovard, a financial adviser.
Vanguard clients who rolled money into an IRA in their 20s held onto the cash in those accounts for an average of seven years, compared with five months for investors who rolled money into an IRA around age 55.
A boost for IRA accounts
As baby boomers retire and younger workers change jobs, dollars transferred to IRAs from 401(k)-type accounts rose to $701 billion in 2023, up from $404 billion in 2013, according to research and consulting firm Cerulli Associates.
Vanguard researchers want policymakers to address the cash issue by extending to IRAs the legal protections available under a 2006 law that allows 401(k) plans to automatically enroll workers in diversified portfolios, such as target-date funds.
Vanguard is the largest provider of target-date funds, according to Morningstar.
Such a policy would add more than $100,000 to the average IRA balance by the time an investor under age 55 reaches age 65, Vanguard estimates.
Mark Iwry, a former Treasury Department official who oversaw domestic retirement policy in the Clinton and Obama administrations, said the option for IRA investors to invest in target-date or similar funds would, overall, be a significant improvement. But, Iwry added, because IRAs differ from 401(k)s in important ways and are subject to different rules than 401(k)s, Congress would have to weigh concerns about important issues, such as fees on IRAs’ default funds, before enacting changes.
Write to Anne Tergesen at [email protected]
