Rolling Over Your 401(k) to an IRA Can Cost You Tens of Thousands. What to Do Instead.
Retirement savers would do well to check the fees on fund holdings in 401(k) accounts held at former employers before rolling over to an IRA. Workplace savings plans tend to have more favorable fund fees.
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Workers who roll over their 401(k) into an IRA when leaving their job may be setting themselves up to lose tens of thousands of dollars to higher fees, a finding that suggests many job-hoppers would do better to leave their savings with their old employers.
The problem, according to a report released Thursday by the Pew Charitable Trusts, stems from favorable fee structures in mutual funds generally found in employer-sponsored retirement plans like 401(k)s but not available to retail investors in individual retirement accounts.
Among mutual funds that primarily hold stocks, annual expenses for median retail shares were 0.34 percentage point higher than those for institutional shares, according to the Pew report. While that might not seem like much, it’s about 37% higher, the report noted.
“It’s not the rollovers themselves that’s the issue,” said John Scott, director of the Pew Charitable Trusts’ retirement savings project. “The issue is we’re essentially moving money from an account with one fee structure to an account with another fee structure.”
Costly Fees
If savers aren’t aware of potential differences in fees, it can hurt them in the long run. The report, which analyzed 2019 data, looked at a typical midcap stock fund and found that one of its institutional share classes had an expense ratio of 0.74%, while a retail share class of the same fund had an expense ratio of 1.1%. At TIAA, the average weighted expense ratio for stock funds is 0.76% for retail, versus 0.48% for institutional, while for the same type of funds at Vanguard it’s 0.1% for retail and 0.09% for institutional.
These seemingly small differences can add up. A worker who retires at age 65 with $250,000 and rolls her 401(k) to an IRA will wind up with $20,513 less at age 90, according to an illustration in the report that assumes a hybrid fund with a 0.65% expense ratio in the IRA, versus 0.46% in the 401(k) plan. It also assumes a real rate of return of 5% a year and monthly withdrawals of $1,000.
For younger workers, the loss to higher fees is even greater. A 26-year-old who rolls over a 401(k) balance of $30,000 into an IRA would have $64,647 less at age 66 in a stock fund with a 1.24% annual fee in an IRA, versus a 0.9% fee for the same fund in a 401(k), according to an illustration in the report that assumes a real rate of return of 8% a year and no further contributions after the initial rollover.
How to Handle
So what’s a saver to do? Investigating your fund fees is a good place to start. You can find them online, plus retirement plans are required to send participants an annual fee disclosure that outlines them.
Then when you’re leaving your job, look into your options. If your account balance is over $5,000, you’re generally allowed to leave your 401(k) where it is, with your old employer’s plan. It becomes inactive, so you can’t contribute to it any longer, but you can still take advantage of potentially lower fees and any market growth that your existing balance experiences over time.
If your balance is between $1,000 and $5,000 and you don’t elect to roll over or cash out your account, your employer is allowed to roll your account over into an IRA that it sets up for you. And if your balance is under $1,000, your employer is allowed to cash you out of the plan and send you a check without your permission.
Among Vanguard plan participants, 52% remained in their old plan when they left their job in 2021, while 18% rolled their 401(k) over into an IRA and 29% cashed out their account in a lump sum, according to the company’s recent report, How America Saves 2022.
It’s not always the case that an employer-sponsored 401(k) plan offers lower fees than an IRA. Some small employers may not have access to institutional pricing, which could have high account minimums and other requirements, said Dave Stinnett, principal and head of Strategic Retirement Consulting at Vanguard. What’s important is that workers compare the fees and make an informed decision, he added.
Write to Elizabeth O’Brien at [email protected]
