Retirement Savings Mistakes: This Misstep Could Cost Job Switchers More Than $100K
Written by
Nicole Symon
Edited by
Joe Evans
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Saving for retirement is key to securing your financial future. To help, employers often offer 401(k) plans, through which employees can put away some of their income for retirement. Many employers also match some of the employee’s contributions.
However, complications can arise when you switch jobs. What happens to the money in your 401(k) account? You generally have two options: roll over your retirement savings into another 401(k) with your new employer or roll them over to an individual retirement account.
According to new research from Vanguard, many job switchers who choose to transfer their funds into an IRA make a simple mistake that can cost them thousands. Learn how IRA rollovers work to avoid this costly mistake.
How Do IRA Rollovers Work?
If you choose an IRA rollover when you switch jobs, your previous employer may deposit your savings into an IRA for you. Alternatively, your employer may send you a check, which you must then deposit into an IRA within 60 days.
Employers don’t sponsor IRA accounts. You, the account owner, are solely responsible for managing your retirement savings.
People who are used to 401(k) accounts can get tripped up because, by default, those accounts direct the money toward investments like target-date funds. Your retirement savings in a 401(k) are automatically funneled toward investments that help them grow.
IRAs are different. By law, IRA accounts must direct most rollovers and all direct contributions into a cash balance. It’s the default option. Your money won’t go directly into any investments like with a 401(k) plan.
The Costly IRA Rollover Mistake Many Job Switchers Make
More than a quarter of IRA rollovers stay in cash for at least seven years. Certain groups, like those with smaller balances, women and younger investors, are more likely to leave their retirement savings in cash after a rollover.
It seems that many workers don’t know that their IRA rollovers go to a cash balance by default, not investments: Two-thirds of people surveyed didn’t know what their IRA savings were invested in, and just one-third said they deliberately left their IRA funds in cash. If you don’t realize that your funds are in cash, you lose out on the potential returns if you were to invest them.
“If you think you are invested, think again,” Andy Reed, one of the authors of the Vanguard study, said. “I know a lot of people with IRAs who think they are invested, and when they check, they are unpleasantly surprised.”
Comparing Returns From Cash vs. Investments
Financially, there’s a big difference between leaving your money in cash and investing it.
Between 1970 and 2023, large-company stocks in the U.S. returned 10.5% per year on average, and small-company stocks returned 9.9%. By contrast, cash typically earns little to no interest. If you leave your IRA rollover in cash, you’re missing out on significant potential returns.
Vanguard’s research shows that workers under 55 years old who leave their IRA funds in cash miss out on at least $130,000 by age 65 compared to workers who invest their IRA money in a target-date fund. Collectively, that adds up to $172 billion of lost investment gains each year from IRA funds left in cash.
Say you have $10,000 in a 401(k) account. You switch jobs, roll over your 401(k) money into an IRA and do nothing. The money will stay in cash, and after 10 years of no additional contributions, you’ll still have $10,000.
If you had immediately invested that money in your IRA, it could have grown. Assuming a 10% return from investing your money in the stock market, you’d have more than $25,000 in your IRA.
How To Avoid This Mistake
Make sure you don’t miss out on potential investment gains. Check your IRA to see whether your money is being invested.
If your IRA funds are in cash, now’s the time to select the investment options you prefer. You can invest your savings in securities like stocks, mutual funds and bonds. These investments have risks, of course, and don’t guarantee returns, but they have historically offered much better growth than cash.
If you’re not sure where to start, a target-date fund might be the best option. Target-date funds are long-term investments that are designed to suit a specific retirement date. For example, if you plan to retire around 2050, you might select a fund called “Retirement Fund 2050.”
These funds often contain stocks, bonds and other securities. The mix generally gets more bond-heavy as your retirement date approaches to reduce your risk.
Explore your investment options and decide how to handle your IRA funds, proactively ensuring that you won’t lose out on money by accident.
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