The Biggest 401(k) Rollover Mistake

  Readers of these columns know that for years I held off rolling over my old 401(k) balances.

Oh, I had rational reasons for (not) doing so; the institutional pricing of a particular fund in one, the low fees in another, the managed account option in a third—but the reality was that the process of rolling over your accumulated savings has been—and in many cases remains—painful.

Rollovers are a big deal. Vanguard reports that annual contributions to IRAs ($701 billion as of 2020) far exceed all DC plan contributions, largely due to rollovers ($618 billion in 2020), while the Investment Company Institute claims that investors now hold an estimated $13.5 trillion in IRAs—“approximately $3 trillion more than in DC plans, despite the fact that 45 million fewer Americans own IRAs than participate in DC plans,” according to the report

Two things, in particular, stayed my hand over the years—trying to time the liquidation of funds (I know, but I’m human), and worrying about the timing I’d be out of the market while a hardcopy check found its way to me through the United States Postal Service. As it turned out—and much to my disappointment—both remained relevant issues as I consolidated my retirement savings.

One issue I didn’t face was one recently highlighted in a Wall Street Journal article, based on a new report by Vanguard. The headline of the former was “The 401(k) Rollover Mistake That Costs Retirement Savers Billions”—that mistake? Leaving those rollover balances in cash.

The Vanguard analysis notes that 28% of rollover investors[i] stayed in cash for at least 12 months, with minimal changes after the first three months following the contribution. More than that, the report notes that among rollovers conducted in 2015, 28% remained in cash for at least seven years[ii]—and explains that younger investors, women, and those with smaller balances are especially prone to staying in cash for years following a rollover.

Now, 28% is hardly a majority—and it pales in comparison to the number of individuals who contribute directly to an IRA who leave those balances sitting in cash. Still, the WSJ manages to find a situation where a couple who rolled over $400,000 into an IRA, and then “couldn’t figure out why they weren’t earning any money when the stock market was showing high returns.”

What seems a more common occurrence was another individual who had her $3,200 account automatically cashed out to an IRA—she was apparently unaware of the account until she got a statement from the IRA—and was dismayed to discover it was “not even in a high–yield money-market fund.”

Vanguard’s analysis is leading it to recommend a QDIA for IRAs (a cynic might wonder if the latter is leading to the former). The paper claims that such a sanctioned device would—for investors under age 55, anyway—relative to staying in cash—provide, on average, an increase of at least $130,000 in retirement wealth at age 65—$172 billion in long-term benefits to all rollover investors in retirement each year.

Let’s face it—while target-date funds were long gaining traction as a 401(k) investment, they really took off after the Pension Protection Act of 2006 provided structure and a safe harbor for their implementation as a default investment. Similarly, the Vanguard recommendation notes that “implementing an IRA QDIA today may involve offering IRA providers safe-harbor relief from fiduciary liability and permitting transactions that are at risk of being deemed ‘self-dealing’ and thus prohibited. Accordingly, it would be important to ensure that appropriate oversight and protections are in place to prevent investors from being exposed to high-cost default investment products.” 

Indeed. 

Because if there’s anything worse than the mistake of not investing your rollover—it’s not rolling it over in the first place.

 

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[i] On the other hand, Vanguard comments that twice as many—55%—of direct contribution investors left those monies in cash.

[ii] Across all rollovers, the median time between rollover and investing was actually nine months, with 28% of rollovers that transferred in cash remaining uninvested for at least seven years.

(Not) Standing Still

A recent headline screamed that 401(k) savings rates have “stagnated” – but that’s missing the point. Several of them, actually.

“Stagnated” in this case apparently means that the average savings rate in 2018 — both employee and employer contributions — was 10.6%, roughly the same as the 10.4% rate reported in the survey in 2004. The point seems to be that, despite roughly a decade of automatic enrollment and other plan design enhancements, Americans aren’t saving any more.

That’s a perfectly obvious point to draw from those two datapoints – in this case from the recent 2019 How America Saves report from Vanguard which, while it only covers plans recordkept by Vanguard, the experience of 1,900 plans and 5 million participants in the survey always provides some interesting insights.

First a couple of basics; what do you suppose the odds are that we have the same plans (and participants) in the 2004 and 2019 surveys? Exactly. So, while it may not be apples to oranges, it’s clearly not pure apples to apples, either. The Vanguard authors themselves at one point acknowledge that there has been an impact to the report averages due to bringing on new plans with lower account balances. Secondly – and I’ve written about this previously – averages are mathematically simple, but can gloss over individual details.

There is, however, much more going on behind the scenes than the average conveys[i]. The reality is that automatic enrollment, while it boosts participation, actually – initially – depresses average savings rates. Why? Because while it generally lifts the participation rate from 70% or so to 90% or so, at the same time it “creates” a whole new group of people saving at a default rate (typically 3%)[ii], whereas those who signed up voluntarily save at rates more than double that. Consequently, you might well expect that a decade of automatic enrollment plan designs might have done good things for participation, they might well have depressed savings rates – and yet, they haven’t.

Some of that can be attributed to improvements in those automatic designs; in 2018, echoing results from the Plan Sponsor Council of America’s 61st Annual Survey of Profit Sharing and 401(k) Plans, slightly more than half of plans chose a default rate of 4% or higher, whereas in 2008 only about a quarter (27%) of plans did. The report also notes that in 2018 23% of plans chose a default rate of 6% or more – more than double the percentage that did so in 2009. And while it has long been the “norm” to apply automatic enrollment provisions to new hires only, the newest Vanguard report finds that it has now been applied to all non-participants in half the plans.

Better still, two-thirds of the plans with automatic enrollment have now implemented automatic annual deferral rate increases, and as of 2018 that has served to narrow the spread between deferral rates for participants in voluntary enrollment plans and those with automatic enrollment to just 0.4 percentage points!

Not that there isn’t room for “improvement”; just one-in-five had a deferral rate of 10% or higher in 2018, and – to the point above, 3 in 10 had a deferral rate of less than 4%. Moreover, only 13% of participants capped out at the 402(g) limit ($18,500), and in plans that allow catch-up contributions for those aged 50 and more, only 15% took advantage of that opportunity in 2018. And – even among the highest paid workers, 6% of those eligible aren’t (yet) taking advantage of that opportunity.

The dictionary defines “stagnant” as “showing no activity; dull and sluggish.” Well, while one number may make it seem that retirement savings has been standing still, the reality is quite different – and not at all "stagnant". 

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[i] To their credit, the Vanguard report authors take pains in the space of the 112-page report to not only provide median, as well as average figures, but to break data down by tenure, salary, and in some cases, age, as well as for participants who have been consistently in their database over a period of time.

• [ii] The Vanguard report notes that even among individuals earning less than $30,000 in plans with automatic enrollment have a participation rate more than double that of those in plans with voluntary enrollment.