The common 401(K) rollover mistake costing savers tens of thousands

Americans are missing out on investment gains because they accidentally withdraw their retirement savings from the stock market after changing jobs, experts warn.

When people transfer a 401(K) work plan to an individual retirement account, the money is often held in cash until the saver chooses new investments.

However, many Americans forget to select new investments and inadvertently leave their money in cash, new research from the Vanguard Group shows.

This means they are missing out on a total of $172 billion in retirement wealth that could have been generated if they had put the money into stocks and bonds instead. This could amount to as much as $130,000 per person.

The research found that younger investors, women and investors with smaller balances are particularly likely to sit in cash for years after a rollover, missing out on valuable gains through compound interest.

For investors under age 55, Vanguard estimates that the long-term benefit of investing in a target-date fund, relative to investing in cash, is equivalent to an average increase of at least $130,000 in retirement wealth by age 65.

According to Vanguard, cash is the de facto standard for individual retirement account (IRA) contributions.

This is despite the fact that it is generally prohibited as a default investment option in workplace 401(K) plans.

According to Vanguard, IRA money is very “sticky.”

Unless Americans voluntarily invest their IRA assets in stocks and bonds, they are typically stuck in cash indefinitely.

Of the rollovers performed in 2015, 28 percent remained in cash for at least seven years.

This mistake is common and can be expensive, especially for younger employees, as they are used to having their pension savings automatically invested in a company pension fund.

Stocks and bonds generally provide much higher returns than cash.

Cash-like investments have gotten a boost since the Federal Reserve raised interest rates, from near zero in 2021.

Money market funds currently pay an annual interest rate of about 5 percent, The Wall Street Journal reported.

According to investment research firm Morningstar Direct, U.S. large-cap stocks rose an average of 7.19 percent per year, compared with just 0.31 percent for cash.

Over the years, compound interest causes these larger stock market gains to increase. The effect is that more and more income is earned on an ever-increasing account balance.

Holding retirement savings in cash is also an issue for older savers, who often need some exposure to stocks to ensure their money lasts. The Wall Street Journal reported.

The huge amounts of money being inadvertently stashed away in cash are a growing concern as IRAs have become the primary way Americans manage their retirement savings, Fiona Greig, global head of investment research and policy at Vanguard, told the outlet.

Holding retirement savings in cash is also an issue for older savers, who often need some exposure to stocks to ensure their money lasts.

IRAs have become the dominant way Americans manage their retirement savings, said Fiona Greig, global head of investor research and policy at Vanguard

Brie Pio, a Maine-based financial advisor, said a couple who hired her in 2021 had moved more than $400,000 from a 401(K) plan into an IRA the year before.

They didn’t realize the money was in cash and Pio estimated they lost about $100,000 by missing a stock market rally.

“They couldn’t understand why they weren’t making money when the stock market was showing high returns,” Pio said.

Americans who quit their jobs can keep their 401(k) balance with their old employer, roll it over to a new 401(k) work plan, or roll it over to an IRA.

An IRA gives savers more options for investing their money, but it is generally not invested in the market.

According to Andy Reed, head of investment behavior research at Vanguard, some people put off making decisions about where to invest their money because they’re overwhelmed by the thousands of options IRAs offer.

Others mistakenly assume that the company that serves as custodian of their IRA, such as Vanguard or Fidelity Investments, will automatically invest their savings for them, as many 401(K) plans do.

Without reminders to invest, “many IRA investors would be stuck in cash forever,” he added.