The Biggest 401(k) Rollover Mistake

Readers of these columns know that for years I held off rolling over my old 401(k) balances.

Oh, I had rational reasons for (not) doing so; the institutional pricing of a particular fund in one, the low fees in another, the managed account option in a third—but the reality was that the process of rolling over your accumulated savings has been—and in many cases remains—painful.

Rollovers are a big deal. Vanguard reports that annual contributions to IRAs ($701 billion as of 2020) far exceed all DC plan contributions, largely due to rollovers ($618 billion in 2020), while the Investment Company Institute claims that investors now hold an estimated $13.5 trillion in IRAs—“approximately $3 trillion more than in DC plans, despite the fact that 45 million fewer Americans own IRAs than participate in DC plans,” according to the report

Two things, in particular, stayed my hand over the years—trying to time the liquidation of funds (I know, but I’m human), and worrying about the timing I’d be out of the market while a hardcopy check found its way to me through the United States Postal Service. As it turned out—and much to my disappointment—both remained relevant issues as I consolidated my retirement savings.

One issue I didn’t face was one recently highlighted in a Wall Street Journal article, based on a new report by Vanguard. The headline of the former was “The 401(k) Rollover Mistake That Costs Retirement Savers Billions”—that mistake? Leaving those rollover balances in cash.

The Vanguard analysis notes that 28% of rollover investors[i] stayed in cash for at least 12 months, with minimal changes after the first three months following the contribution. More than that, the report notes that among rollovers conducted in 2015, 28% remained in cash for at least seven years[ii]—and explains that younger investors, women, and those with smaller balances are especially prone to staying in cash for years following a rollover.

Now, 28% is hardly a majority—and it pales in comparison to the number of individuals who contribute directly to an IRA who leave those balances sitting in cash. Still, the WSJ manages to find a situation where a couple who rolled over $400,000 into an IRA, and then “couldn’t figure out why they weren’t earning any money when the stock market was showing high returns.”

What seems a more common occurrence was another individual who had her $3,200 account automatically cashed out to an IRA—she was apparently unaware of the account until she got a statement from the IRA—and was dismayed to discover it was “not even in a high–yield money-market fund.”

Vanguard’s analysis is leading it to recommend a QDIA for IRAs (a cynic might wonder if the latter is leading to the former). The paper claims that such a sanctioned device would—for investors under age 55, anyway—relative to staying in cash—provide, on average, an increase of at least $130,000 in retirement wealth at age 65—$172 billion in long-term benefits to all rollover investors in retirement each year.

Let’s face it—while target-date funds were long gaining traction as a 401(k) investment, they really took off after the Pension Protection Act of 2006 provided structure and a safe harbor for their implementation as a default investment. Similarly, the Vanguard recommendation notes that “implementing an IRA QDIA today may involve offering IRA providers safe-harbor relief from fiduciary liability and permitting transactions that are at risk of being deemed ‘self-dealing’ and thus prohibited. Accordingly, it would be important to ensure that appropriate oversight and protections are in place to prevent investors from being exposed to high-cost default investment products.”?

Indeed.?

Because if there’s anything worse than the mistake of not investing your rollover—it’s not rolling it over in the first place.

?

[i] On the other hand, Vanguard comments that twice as many—55%—of direct contribution investors left those monies in cash.

[ii] Across all rollovers, the median time between rollover and investing was actually nine months, with 28% of rollovers that transferred in cash remaining uninvested for at least seven years.