Individual Retirement Accounts, or IRAs, are the dominant retirement account in America today. Nearly 4 in 10 Americans have one, and as of last year, those accounts held $13.5 trillion in total assets, according to Alicia Munnell, director of Boston College’s Center for Retirement Research.
But these would-be retirees are losing billions of dollars to high IRA fees when they turn their 401(k) accounts into similar IRA accounts — even if they choose the same underlying investment, according to a published Pew analysis. last week.
These relatively small fee differences can snowball into big losses over time, Pew found. It’s particularly damaging because retirees typically live on fixed incomes, which means a reduction in a worker’s potential retirement savings can have a lasting impact on their standard of living in retirement.
“Overall, the amount of retirement savings lost in such rollovers potentially reaches tens of billions of dollars,” the report said.
The bulk of IRA investment comes from workers quitting their jobs and transferring assets from their previous 401(k) plans.
When a person leaves a job with a 401(k) plan, they have several options:
- Keep their funds in their employer’s old plan, if the employer allows it
- Move their old 401(k) to their new employer’s plan, if one exists
- Roll it into an IRA
Many people like IRAs because of the convenience of tracking all of their retirement savings in one place and the ability to choose from a number of investment options. But financial institution marketing also heavily favors IRAs, a government watchdog discovered in 2013.
Institutions refer workers to IRAs without understanding their specific circumstances, while workers may not understand that they are being sold a product, the Government Accountability Office found.
That’s bad news for investors, who can end up with much higher fees from an IRA — even when the underlying investment product is the same, Pew found.
The difference comes from what are called share classes. Mutual fund stocks come in different flavors, called classes, depending on whether they are aimed at individual investors or institutional investors.
Even though all classes of shares are invested in the same basket of investments – stocks, bonds, real estate and other investments – different classes may offer different features or services or have different underlying expenses for marketing, administration and other costs.
Institutional shares – a class of mutual fund shares that are only available for sale to institutions – generally require a large minimum investment, sometimes $100,000 or more, which makes them available only to employers who pool the individual contributions of many people or to very wealthy people. Because institutional investors have a lot more money to spend, these share classes have the lowest fees.
Retail stocks, on the other hand, are aimed at individuals and have low to no minimums. But retail share classes often charge much higher management fees than investor classes – a loss that accumulates over time.
Also, many investors may not understand that they are being charged higher fees. “Disclosure of Fees [for these accounts] are written in a technical way that is difficult for the average consumer to understand,” according to Pew. And, like the “terms and conditions” of many online accounts, this information is often not read.
A class difference
But the fee differences can be significant, Pew found.
Equity-based investment funds typically have expenses that are 37% higher for retail investors than institutional investors, Pew found, while median expenses for bond-based funds are typically 56% higher.
Hybrid funds, which invest in both stocks and bonds, have the lowest expense difference. However, with typical hybrid fund billing fees being 31% higher for retail investors, the markup is still significant.
And because fees reduce the amount of retirement savings that can accumulate and grow over time, they can amount to tens of thousands of dollars in lost retirement savings.
“At first glance, the differences seem small, but they can significantly affect savings over time,” says Pew.
In an example offered by Pew, a worker retires at age 65 with a substantial 401(k) balance of $250,000, and rolls it into the same investment fund in an IRA. Because of the higher IRA fees, she would have $20,513 less in income after 25 years.
A mid-career worker who moves that same $250,000 balance from a low-cost 401(k) to a high-cost IRA could lose significantly more, ending up with a lower account balance of $137,630 after 25 year.
“Because higher fees erode subsequent gains, the magnitude of the savings reduction is even greater than the magnitude of the fee increase,” Pew notes.
For an early-career worker transferring $30,000 from a 401(k) to an IRA, higher IRA costs after 40 years would result in a balance $64,000 lower than it otherwise would have been.
To slow the erosion of workers’ retirement savings, Pew recommends that employers help workers who leave with 401(k) rollovers, either by allowing them to keep their 401(k) where they are, or by helping them resist the marketing of high-cost financial products. .