Americans are missing out on hundreds of billions of dollars in lost retirement cash because of a simple, forehead-slapping mistake in managing their IRA accounts.
That’s the conclusion of new research by Vanguard, the investment firm, into the lackluster performance of many individual retirement accounts.
The problem comes with rollovers, the transfer of funds from an employer-sponsored retirement plan to a traditional IRA when someone leaves a job.
Looking at IRA rollovers completed in 2015, Vanguard found that 28% of savers still had their funds in cash seven years later, in 2022.
That act of omission, Vanguard estimates, costs investors at least $170 billion a year in lost retirement wealth.
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Here’s the problem: When someone leaves a job and rolls over a 401(k) into an IRA, the money almost always arrives as cash, or a cash equivalent, such as a money market fund. Those accounts typically earn less than 1% interest a year, although higher rates exist.
To put the money back to work, the investor has to log in to the retirement account, or pick up the telephone, and re-invest the funds in the stock and bond markets.
Failing to do so, and leaving a rollover IRA in cash, costs an individual investor at least $130,000 in lost wealth by age 65, assuming the rollover happens by age 55, according to Vanguard research.
“A lot of investors mistakenly assume that reinvestment is automatic,” said Andy Reed, head of investment behavior research at Vanguard.
“The number of experts – and by experts, I mean people with PhDs – who we’ve talked to who said, ‘I did this, or my spouse did this, or my adult child did this,’ it’s been absolutely mindboggling," he said.
Stories of rollover IRAs wallowing in cash for decades, and missing out on hundreds of thousands of dollars in compound interest, are the stuff of nightmares, some financial advisers said.
Michelle Crumm, a certified financial planner in Ann Arbor, Michigan, recently took on a new client. The client was in her mid-50s. She had managed to save $200,000 in retirement funds in her 20s at a high-paying job.
“And it’s been sitting in cash,” she told Crumm.
Crumm did some quick math in her head. Over 25 years, at 8% interest, the client’s $200,000 would have grown to well over $1 million.
She did not share that figure with her client: What was the point?
“I always just try to take people where they’re at. History’s history,” she said. “I’m sure I gasped.”
Rarely, advisers say, does the personal finance world offer such an easy and potentially lucrative fix:
If you have an IRA, take a look at the holdings. If they are in cash, or a money market account, consider moving them into stocks and bonds to avoid missing out on a trove of investment earnings in the years to come.
“We’re not talking about a small sum of money. We’re talking about a large chunk of money,” said Heather Winston, assistant vice president and head of product strategy at Principal Financial Group.
It might seem improbable that millions of Americans have billions of dollars in retirement savings that they forgot to invest.
But Vanguard’s research found that the typical investor waits nine months after an IRA rollover to invest the funds. Many savers wait much longer. The average young investor, ages 20 to 29, allows an IRA rollover to sit in cash for seven years.
When Vanguard surveyed investors who had left their IRA funds in cash, they found that most clients didn’t realize the funds weren’t already invested.
Investment advisers concur.
“I’ve worked with clients who kept their funds in cash for years, mistakenly thinking the account itself handled the investing,” said Spenser Liszt, a certified financial planner in Dallas.
Liz Windisch, a certified financial planner in Denver, also said she has seen IRA funds languish in cash “many, many times.”
Some clients never realized the money wasn’t invested, Windisch said, “But more often, it is someone who plans to do something and keeps kicking the can down the road, and now it’s two years later.”
Retirement savings accounts are designed to encourage workers to set aside earnings toward their post-employment years.
Common wisdom suggests most of the savings should be invested in the stock market, where the money can be expected to earn around 10% a year over time. Savers often invest a smaller share of their funds in bonds, which offer lower returns but provide a hedge against the volatility of stocks.
When a worker enrolls in a 401(k), the account generally has a default setting that invests the funds in some sensible mix of stocks and bonds, often keyed to the employee’s expected retirement year. That means the worker’s savings will grow, even if the employee never makes investment choices.
IRAs are different. When a worker leaves a job and rolls over a 401(k) into an IRA, the investments are usually liquidated and the funds converted to cash or some cash equivalent.
“And many investors fail to take the next step,” Reed said, “which is reinvesting.”
The same rules apply to IRA contributions. And Vanguard found the same problem when investors contribute to IRA accounts: 12 months later, many of those contributions remain in cash.
Solving the problem sounds simple enough. Someone – a financial adviser, ideally – needs to alert a retirement saver whose IRA is stalled in cash. But that doesn’t always happen.
“I think we, as an industry, need to do a much better job at saying, ‘Let us help you with this stuff,’” said Winston at Principal. “Firms like ours have to be prepared to make recommendations about what to do.”
Investment firms could, for example, flag an IRA account that has sat in cash for more than a year and send a message to its owner, reminding them of the benefits of investing.
Vanguard has worked on helping IRA investors find suitable investments for their cash, sending pro-active messages and simplifying the process for re-investing, a company spokesman said.
That initiative may explain why Vanguard is seeing improvement in its rollover cash problem. For rollovers initiated in 2022, only 28% of the accounts remained in cash after 12 months.
Among 2015 rollovers, by contrast, 28% remained in cash after seven years.
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In a recent policy paper, Vanguard urged lawmakers to change IRA regulations so rollover funds invest automatically. That way, if the saver failed to act, the funds would default into a mix of stocks and bonds.
“Uninvested cash in retirement accounts is a significant problem that hinders millions of Americans saving for retirement,” the report states. “Accordingly, a systematic solution is needed.”