Americans Lose Trillions From 401(k) Rollovers — Here’s How to Fix It
During the first couple of years following the economic crisis of 2008, there were numerous stories that featured Americans nearing retirement age whose 401(k) accounts had lost a significant amount of money. For example, in 2009, CBS interviewed several people in their 50s and 60s who had seen their life savings reduced by 50 percent or more. Many expressed their disappointment that the dream retirement they had anticipated for so many years would never materialize — if they were even able to retire at all. Millions of Americans lost trillions of dollars when their investments tanked. However, Americans are still losing several trillion dollars from their 401(k) accounts when they change jobs — even though it would not be a difficult problem to fix.
How to Stop the Trillions Lost Through 401(k) Rollovers
In the United States, there is no centralized database that tracks defined-contribution accounts such as 401(k) savings accounts. Nor is there a centralized, standard mechanism that provides an easy way for workers to roll over their existing 401(k) to a new employer’s plan. Therefore, many workers leave their 401(k) behind when they change employers. Some people naively expect their former employer to maintain the account and that the money will be safe until they decide to roll it over or access it when they retire.
Unfortunately, there is seldom a happy ending when a 401(k) is abandoned. If the balance is under $5,000 — $20,000 if certain conditions are met — many companies will roll the account into an IRA. The investments are typically money-market accounts or other low-risk types of investments. The returns are seldom sufficient to cover the fees associated with the IRA. To illustrate, $1,000 in an account converted to a low-return, high-fee IRA could disappear completely in less than a decade. Even if the former employer does not push out the account, it is quite likely that additional administrative fees can quickly reduce the balance, according to Forbes.com.
Companies are not out to sabotage the retirements of former employees. If you consider the matter from the company’s perspective, there is a certain logic involved. A 401(k) is a benefit offered to employees, but once a worker leaves, the company likely does not want to keep incurring the expenses involved to maintain the accounts for former employees. Because the Department of Labor guidelines instruct employers to prevent exposing the money of employees to risky investments, employers simply choose a safe investment — such as an IRA.
Rolling over a 401(k) can be a complicated matter. Many people find that the logistics are too difficult for them to manage, so they either cash out the account or end up collecting a number of small-dollar 401(k) accounts during their working years. Instead of their retirement savings growing, they are disappearing.
The primary issue is the failure to deploy adequate technology. In many countries, a central pension registry allows employers and workers to track where the money is and to whom it belongs. Often, the system proactively rolls accounts into a centralized program that leverages scale to help produce better returns. When considering who should be responsible for a pension clearinghouse, the obvious candidate is the Social Security Administration. After all, this is the agency that tracks every individual’s earnings to determine his or her retirement and disability payments. Unfortunately, the agency has objected to taking on the task.
If no government agency is willing or able to help, the private sector will need to rise to the challenge. Some companies have already begun to offer assistance to new hires who want to roll over an existing 401(k). Others are using programs that encourage portability and automatic rollovers.
If Rolling Over a 401(k) Can Be Made Easier, What Is the Stumbling Block?
One potential roadblock is the issue of fiduciary responsibility. By law, anyone functioning as a fiduciary must have no potential conflict of interest, always place the beneficiary’s interests first and always act in their client’s best interests. Although the law originally applied only to advisors receiving fees for their services on retirement plans, the scope has been redefined to include any professional who makes a recommendation. The change has left the legal departments in some companies wondering how far they can go to advise employees on their 401(k) accounts. According to Investopedia.com, providing education or general investment advice is not covered by the law. However, the article also notes that rollovers from 401(k) accounts to IRAs are going to be subjected to particular scrutiny. Also remaining unresolved is the issue of whether the new employer or the former employer will be considered to have fiduciary responsibility for the account.
Best Practices for Dealing With a 401(k)
A 401(k) can be an excellent way to fund your retirement, but you need to educate yourself on the investment options. Whether you choose extremely safe investments providing low returns or riskier investments offering the chance for high returns is a matter for you to discuss with a qualified, reputable financial adviser.
Many times, the best way to handle a 401(k) when you change jobs is simply to avoid two mistakes. The first big mistake is to just cash out the account unless you are in dire need of the money. The funds contributed by your employer and those that you contributed as pre-tax dollars — along with the interest earned — become taxable income, and depending on your age, you could also be forced to pay a penalty of 10 percent for early withdrawal.
The second critical mistake you can make when you change jobs is to do nothing about your 401(k). If you simply abandon the account, the money in it can vanish long before you are ready to retire. Even if you consider the money to be a small amount, think about the power of interest. For example, $1,000 in a properly managed 401(k) can easily grow to $2,700 or more in less than 10 years, but the account could fall to zero within the same period if it is invested in a high-fee, low-return account. If you were to change jobs every five years or so throughout your career, just imagine the amount of money you stand to lose — money that could help secure your retirement.
Changing jobs can be an anxious, hectic time. You will probably incur a certain amount of stress during the transition, and you may feel that your 401(k) is not a critical item on your agenda. However, a little additional anxiety now could potentially save you from severe stress once you are ready to retire.
If you would like to explore issues related to personal finance in greater detail, visit the Personal Money Store to find many helpful, educational articles.