Americans are losing hundreds of billions of dollars in retirement savings because of simple, forehead-slapping mistakes in managing their IRA accounts.
That’s the conclusion of a new study by investment firm Vanguard about the poor performance of many individual retirement accounts.
The problem comes with rollovers, which move funds from an employer-sponsored retirement plan to a traditional IRA when someone leaves a job.
Vanguard looked at IRA rollovers completed in 2015 and found that 28% of savers still had their funds in cash in 2022, seven years later.
One mistake can cost investors $170 billion in retirement wealth
Vanguard estimates that this inaction costs investors at least $170 billion a year in lost retirement assets.
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Here’s the problem. When someone quits their job and rolls their 401(k) over to an IRA, that money almost always arrives as cash or a cash equivalent, such as a money market fund. Interest rates on these accounts are typically less than 1% per year, although higher rates exist.
To get their money back, investors must log into their retirement account or pick up the phone and reinvest the money in the stock or bond market.
Vanguard research shows that if you fail to do this and leave your rollover IRA in cash, individual investors will lose at least $130,000 in assets by age 65, assuming the rollover occurs by age 55. Become.
“Many investors mistakenly believe that reinvestment is automatic,” said Andy Reid, director of investment behavior research at Vanguard.
“A number of experts we talked to, and by experts I mean people with Ph.D.s, said, ‘I did this, my spouse did this, my adult child did this. “I did this,” he said.
The story of rollover IRAs languishing in cash for decades and missing out on hundreds of thousands of dollars in compound interest is the stuff of nightmares, according to some financial advisors.
Lost $1 million in savings: ‘It definitely took my breath away’
Michelle Crum, a certified financial planner in Ann Arbor, Michigan, recently took on a new client. The customer was a woman in her mid-50s. She had a well-paying job and managed to save $200,000 for retirement in her 20s.
“And it’s sitting there as cash,” she told Crum.
Krum did some simple calculations in his head. Over 25 years at 8% interest, the customer’s $200,000 grows to well over $1 million.
She did not share that number with her clients. What is the point?
“I’m always trying to take people to places. History is history,” she said. “It definitely took my breath away.”
Advisors say the world of personal finance rarely offers such an easy and potentially lucrative solution.
If you have an IRA, check your holdings. If you have it in cash or a money market account, consider moving it into stocks or bonds to avoid missing out on a trove of investment returns over the next few years.
“We’re not talking about small amounts of money. We’re talking about big amounts of money,” said Heather Winston, assistant vice president and head of product strategy at Principal Financial Group. said.
It may seem unlikely that millions of Americans have billions of dollars in retirement savings that they forgot to invest.
Typical investors have 9 months to invest rollover funds
However, a Vanguard study found that the typical investor waits nine months after an IRA rollover before investing the funds. Many savers wait longer. The average young investor between the ages of 20 and 29 can keep an IRA rollover in cash for seven years.
Vanguard surveyed investors who left IRA funds in cash and found that most customers were unaware that their funds were not yet invested.
Investment advisors agree.
“For years, I’ve worked with clients who kept their funds in cash and mistakenly thought the account itself was handling the investments,” says Spencer List, a certified financial planner in Dallas. spoke.
Liz Windish, a certified financial planner in Denver, said she has also seen IRA funds get stuck in cash “over and over again.”
Windisch said some clients didn’t realize their money wasn’t invested, “but often it’s someone who planned to do something, kept planning, and ended up two years later.” said.
Retirement savings accounts are designed to encourage workers to save their income for retirement.
For rollover IRAs, the default position is usually cash.
Conventional wisdom suggests that you should invest most of your savings in the stock market, where you can expect returns of around 10% per year over the long term. Savers often invest a smaller percentage of their funds in bonds, which have lower yields but can hedge against the volatility of stocks.
When an employee enrolls in a 401(k), the account typically has a default setting that invests funds in a judicious mix of stocks and bonds, often aligned with the employee’s expected retirement year. This means that even if employees do not make investment choices, their savings will increase.
IRAs are different. When a worker quits their job and rolls over their 401(k) to an IRA, the investments are typically liquidated and the funds converted to cash or cash equivalents.
“And many investors are unable to take the next step, which is to reinvest,” Reid said.
The same rules apply to contributions to an IRA. And Vanguard found the same problem exists when investors contribute to IRA accounts. After 12 months, many of those donations remain in cash.
“Please let me help you with this matter.”
It seems easy to solve the problem. Someone (ideally a financial advisor) needs to alert retirement savers whose IRAs are stuck with cash. But that doesn’t always happen.
“I think we as an industry need to do a better job of saying, ‘Hey, let me help you with this,'” Principal Winston said. “Companies like ours have to be ready to make recommendations on what to do.”
For example, an investment firm could flag IRA accounts where cash has been held for more than a year and send a message to the owner reminding them of the benefits of the investment.
Vanguard has been working to help IRA investors find good investments for their cash, send positive messages and simplify the reinvestment process, a Vanguard spokesperson said. .
This effort may explain why Vanguard is seeing improvements in its rollover cash problem. For rollovers that began in 2022, only 28% of accounts had cash remaining after 12 months.
In contrast, 28% of 2015 rollovers remained in cash after seven years.
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In a recent policy paper, Vanguard urged lawmakers to change IRA regulations so that rollover funds automatically invest. That way, if the saver fails to act, the funds will default into a combination of stocks and bonds.
“Uninvested cash in retirement accounts is a significant problem that prevents millions of Americans from saving for retirement,” the report states. “Therefore, we need a systematic solution.”