Opinion: Americans are leaving old 401(k) accounts behind — and paying the price
Remember that 401(k) from your first job? What happened to it? If you’ve lost track of your old accounts, you’re not alone; Millions of Americans leave 401(k) accounts in their former employer’s plans each year.
It’s not hard to come across statistics that show how inadequate our collective savings are. While some of that is an unfortunate reality of our modern labor market and income inequality, much of it comes from the conflict attached to our retirement savings systems. In particular, the fact that our retirement accounts like 401(k)s are tied to our employers. And we often do things wrong with them when we change jobs, like withdrawing money or forgetting about them.
Leaving behind old 401(k) accounts is more common than you think. In some recent analysis we did with the Center for Retirement Research at Boston University, we estimated that there are more than 24 million forgotten 401(k) accounts holding 1.35 trillion dollars in assets and another 2.8 million accounts are left behind every year. This is not hard for me to believe – I left the account myself, as well as a lot of friends and family members.
How did we get here?
401(k)s are common, Americans already save more $6.7 trillion in 401(k) accounts. These accounts are “employer-sponsored”, which means they are provided by our employers. While 401(k) plans are great for saving money, there is one big limitation: many people change jobs every few years, forcing us to decide what to do with the 401(k) of savings we’ve accumulated.
We have several options: we can move them into a new retirement account like an individual retirement account (IRA), cash out (pay huge taxes and penalties), or leave them to their previous owners. Job transitions are hectic times, so it’s no surprise that many people leave behind their 401(k) accounts. As a result, our old 401(k) plans can pile up as we move throughout our careers.
Some of those accounts were intentionally left out because people liked their old 401(k) plan, and that’s great. Unfortunately, however, most of them are left behind inconveniently. And the risk is that those overlooked, forgotten accounts will cost us in overlooked savings. Our analysis shows that a 401(k) left behind can cost Americans $116 billion in retirement savings each year, and up to $700,000 for an individual over their lifetime.
The two main reasons for underperformance are the risk of being charged higher fees and the risk of us forgetting our money was invested.
Many 401(k) accounts charge meaningful fees, but many of us don’t realize it; A recent survey showed that 73% of people don’t know how much they pay in 401(k) fees. While many 401(k) plans charge reasonably low fees, industry data shows that there is a wide range on 401(k) packets. The average 401(k) plans in 2020 cost participants about 0.85% a year, though some plans are as high as 1.5%. Ultimately, the risk is that an individual’s forgotten 401(k) account gets stuck in a high-fee plan and they don’t realize it.
The most significant potential impact comes from suboptimal investment allocation. Here, the risk is that the old 401(k) account is sitting in a lower-yielding instrument rather than a higher-yielding, diversified portfolio.
Unfortunately, this risk is not hypothetical. Many 401(k) plans still default to money market mutual funds or stable value funds – an average of 13% did so between 2010 and 2019. A typical money market mutual fund’s return is less than 1%, while a stable value fund can yield a slightly better 2-3%. Additionally, a well-allocated, diversified retirement account will generate meaningfully better returns over time. That portfolio could be in a 401(k) or managed IRA, or it could be an auto IRA created by an auto custodian. Those robo accounts have returned almost 9% annually for the past three years, while the S&P 500 is popular
ETFs have seen annual returns of nearly 14% over the past 10 years.
Consider an account with a $55,000 balance: a retirement account that charges reasonable fees and returns healthy returns can yield nearly $700,000 to use in retirement over 30 years more than an account The 401(k) is stuck in a high-fee, low-margin account. To put $700,000 into perspective: USDA Estimated Raising a child up to 17 years old costs an average of $233,610.
Of course, many 401(k) plans have reasonable fees and offer good investment options; however, even a well-allocated initial 401(k) needs to be regularly monitored and updated over time. The chances of it happening decrease the longer a 401(k) account is left out.
These neglected 401(k) accounts also result in higher costs for employers – we estimate around $700 million annually. These costs arise from paying administrative fees for former employees who remain on the plan, exposure to lawsuits over their fiduciary duties, and the use of valuable staff time to communicate. with former employees.
In the future, private and public sector initiatives could significantly reduce the number and cost of these accounts for the benefit of individuals and employers. First, we can make it easier to locate older 401(k)s. There is currently no national database of lost and found 401(k) accounts, despite previous Congressional recommendations. Second, we can simplify the complicated and outdated transition process to make it easier to transfer a 401(k) account at the time of a job change to another 401(k) account or IRA. Finally, employers should provide departing employees with user-friendly tools instead of the jargon-laden paperwork that is common today. Giving users modern tools to understand their options and move their money is more likely to lead to informed decisions and fewer forgotten 401(k) accounts.
By highlighting the scale and cost of the problem, we hope to draw more attention to one of the biggest and most underappreciated reasons why retirement savings are America is not like that.
If you are interested in learning more about our research methodology and findings, we encourage you to check out this report with more details.
Gaurav Sharma, is the CEO and co-founder of Capitalization, help people transfer retirement assets.
https://www.marketwatch.com/story/americans-are-leaving-old-401-k-accounts-behind-and-paying-the-price-11627055031?rss=1&siteid=rss | Opinion: Americans are leaving old 401(k) accounts behind — and paying the price