401(k) Rollover Error Costs Employees Billions

Here’s a common scenario: An individual leaves one employer for another. The previous employer offered a 401(k) plan.

The individual rolls over the money in his or her 401(k) into an individual retirement account (IRA) sponsored by the new employer. But the employee doesn’t select index funds that include stocks and bonds to invest in.

“Cash is the de facto default for IRA contributions, despite being generally prohibited as a default investment option,” warns Vanguard in a new research report, Improving Retirement Outcomes by Default: The Case for an IRA QDIA. QDIA stands for qualified default investment option.

“Among rollovers conducted in 2015, 28% remained in cash for at least seven years [emphasis ours],” Vanguard notes. As a result, investors lost a whopping $172 billion in retirement benefits because their money wasn’t in the stock and bond markets. Evidence suggests some folks were likely overwhelmed by the hundreds of investment choices available with their IRA, and then for one reason or another, failed to follow through on selecting funds.

“For investors under age 55, we estimate that the long-term benefit of investing in a target-date fund (versus staying in cash) upon rollover is equivalent to, on average, an increase of at least $130,000 in retirement wealth at age 65,” says Vanguard, which examined 68,00 rollovers worth at least $1K.

Rollover to Just Cash is Fine by Many!

The Vanguard report shows that employees 55 and older are less likely to keep rollover in money market accounts. Which is interesting — the closer one is to retirement, the more it makes sense to be conservative with one’s money. At least that’s the advice financial advisors always gave to their clients. It’s Millennials and Zoomers who need to be more aggressive in their investing strategies.

Yet today more people are invested in traditionally conservative money market funds than ever before — a stunning $6.15 trillion in total assets. Many investors chose to hedge their bets and not over-invest in the stock market despite the bull market of the past six months. No doubt many are counting on a market downturn, and will happily take 4% returns on their cash if and when it does crash.