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Mark Miller: Remaking Retirement

The Hidden Costs of IRA Rollovers

Higher fees can significantly eat into returns when investors move out of their workplace plans.

When you retire or change jobs, you have a decision to make about your 401(k): Leave it where it is, or roll it over to a traditional or Roth IRA. A good case can be made for either decision, depending on the features of your workplace plan and the IRA and underlying investments you might select.

But one thing is clear: The decision can be very consequential for your investment outcome—mainly because of fees. If you roll over your 401(k) to an IRA with higher costs than your workplace plan, the move can do substantial damage to your portfolio value over time.

The Cost of IRA Rollovers

New research by The Pew Charitable Trusts finds that investors potentially can lose thousands of dollars over time owing to what might seem like small differences in total expenses—especially the cost gap between retail and institutional shares.

Pew analyzed the difference between average institutional and retail share class expense ratios across all mutual funds that offered at least one institutional share class and one retail share class in 2019. The review found that annual expenses for median retail shares were 37% higher; for hybrid mutual funds holding both equities and bonds, the differences were larger: around 41%.

Pew applied those differences to the total amount of assets rolled over for a single year (2018) and concluded that it translated to more than $980 million in direct fees just for that year—and potentially tens of billions of dollars in potential losses from fees and forgone earnings over a 25-year investing horizon.

Rollovers are very big business for IRA providers. In 2018 alone, investors rolled $516.7 billion from employer retirement plans into traditional IRAs, the Pew report notes. Brokers and others in the financial services industry love to pitch rollovers to new retirees, in particular, as a way to attract assets for their practices and generate more fees. Indeed, a rollover can make sense if you are in a high-cost 401(k) plan with poor investment choices—moving to low-cost passive index funds could boost your performance substantially over time.

But the Pew study underscores the need to look carefully before leaping. “People should be aware of these fee differences,” says John Scott, who directs Pew’s retirement savings project. “There’s an awful lot of marketing encouraging rollovers—and people don’t always look carefully enough at the fees.”

Indeed, a survey published by Pew last year found that fees are rarely a motivating factor in rollover decisions. The survey queried older workers and recent retirees on the factors that motivated their decisions to stay put or roll over their accounts.

Among workers who remained in their workplace plans, 50% said the most important reason was the plan’s investment options, and nearly three fourths (73%) mentioned fund menus as a contributing factor. Just 15% cited lower fees in their current plan as the most important reason for planning to leave their savings where they are.

Meanwhile, among workers planning an IRA rollover, just 3% cited lower fees as the most important reason. The strongest motivator was the ability to have greater control over their investments.

Failing to pay close attention to fees can be costly. The Pew study offers some illustrations of how differences in cost that might not sound significant can have an impact on outcomes over time—and how the decision can be important for workers at different ages:

  • Sarah retires at age 65 with a $250,000 portfolio and switches from a very low-cost 401(k) with total fees of 0.09% to an IRA that charges 1.44%. Assuming a 5% annual return and a drawdown of $1,000 per month from her account, she has $123,385 at age 90, instead of $161,015.
  • Jim is 26 years old and has saved $30,000 after four years in the workforce. He rolls over the account during a job switch, moving from a 401(k) plan charging 0.9% to one charging 1.24%. Assuming an 8% rate of return and no further contributions, he will have $443,333 at age 66, instead of $507,980 that would have accumulated in the employer plan.

Pew has developed an online calculator that investors can use to explore the impact of fees over time.

When Does an IRA Rollover Make Sense?

IRA rollovers can make sense in some situations. For instance:

  • A rollover can make sense if you’re in a 401(k) plan with poor investment choices or high fees. A study by Morningstar published earlier this year found that people who work for small employers and participate in their defined-contribution plans pay about 88 basis points in total, compared with 41 basis points for participants in larger plans. But small plans have a much wider range of fees between plans, with more than 30% costing participants more than 100 basis points in total, the report found. If you’re not sure about your plan’s expenses, send a written request to your employer’s human resources department and ask for a written response to this question: “What are all the fees I’m paying, direct or indirect, on my account?”
  • Another potential benefit of rolling over is account consolidation. Many people wind up with a number of retirement accounts over the course of their working years as they move from job to job; getting in the habit of rolling funds into a single, low-cost IRA as you move around is a good way to stay organized and avoid losing track of your money. (For an argument in favor of rollovers, check out a podcast interview I did in 2020 with Scott Puritz, managing director of Rebalance, an investment management firm focused on passive index strategies.)
  • A rollover also can make sense if your former employer isn’t eager for you to stick around. Just 20% of plan sponsors actively encourage participants to keep their assets in the plan when they retire, according to an annual survey of workplace plans by the Plan Sponsor Council of America.
  • If you want to set up regular withdrawals for income in retirement and your plan can’t accommodate that, a rollover is a good idea. The PSCA survey found that 63.6% of plans allow participants to take withdrawals on a periodic or regular basis, although the figure is higher for large plans (74.4% among plans with 5,000 or more participants).

Regulatory Protections of IRAs Versus 401(k)s

Investments held in 401(k) plans are subject to the fiduciary requirements of the Employee Retirement Income Security Act, meaning plan sponsors must put the interests of account holders first. Non-Erisa accounts, such as traditional and Roth IRAs, don’t enjoy those protections, although they are protected under federal bankruptcy law should you file for bankruptcy.

The Obama-era fiduciary rule that ultimately was struck down by a federal appeals court in 2018 included a strong best-interest provision on advice provided by advisors on rollovers. The U.S. Department of Labor followed up with a new fiduciary definition applicable to rollovers in 2020. Compliance for advisors was phased in gradually, and it was fully in force starting July 1, 2022. The rule requires advisors to provide plan participants and IRA owners with a specific, written explanation why a proposed rollover recommendation is in their best interest.

“As courts have said, the Erisa fiduciary standard is the highest known to the law,” says Fred Reish, a partner in the law firm Faegre Drinker and an expert on fiduciary issues, prohibited transactions, tax qualification, and retirement income. “As a result, advisors will need to engage in objective and professional analyses in order to determine if a rollover recommendation is in the best interest of a plan participant.”

Once funds have been rolled over to an IRA, the advice is subject to the SEC’s best interest standard. “It’s not a fiduciary level of care,” Reish adds.

Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to The New York Times and WealthManagement.com. He publishes a weekly newsletter on news and trends in the field at RetirementRevised. The views expressed in this column do not necessarily reflect the views of Morningstar.