This common money move costs retirement savers $45.5 billion in investment fees, earnings over 25 years

IRA rollovers — transfers from 401(k) plans to individual retirement accounts — are a common financial move when workers switch jobs or retire. But rollover IRAs can cost Americans billions of dollars in extra fees over decades, according to a study issued Thursday by The Pew Charitable Trusts, a nonprofit research organization.

The dynamic is due to the lower annual fees for mutual funds generally available to 401(k) savers relative to costs incurred by IRA investors.

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“Even small disparities in fees can lead to big reductions in savings,” according to John Scott, who directs Pew’s retirement savings project.

Investors rolled $516.7 billion from workplace plans into traditional IRAs in 2018, the latest year for which data is available. That’s nearly 28 times more money than as contributed to traditional IRAs that year.

A Pew survey from 2021 found that 46% of recent retirees rolled at least some of their workplace retirement funds to an IRA, and 16% of near retirees plan to do so.

A rollover may not be optional, either: About 15% of 401(k) plans don’t allow workers to retain funds in the plan when they retire, according to a survey conducted by the Plan Sponsor Council of America, a trade group.

The typical “hybrid” fund in a 401(k) plan is 0.19 percentage points cheaper than the same fund available to IRA investors, according to the Pew study. (A hybrid fund holds both stocks and bonds.)

That fee differential, which may seem negligible, amounts to big bucks over many years.

Using those figures, Pew estimates that investors who rolled over in 2018 would have collectively lost about $980 million in a year due to extra fees. Over 25 years, their nest eggs would be reduced by about $45.5 billion in aggregate due to fees and lost earnings, according to the analysis. That’s just from a single year’s worth of rollovers.

The typical fee differential in 401(k) plans versus IRAs is even larger for stock funds and bond funds — 0.34 and 0.31 percentage points, respectively.

Pew’s analysis examines fees according to mutual fund “share classes.”

Basically, the same fund can have multiple share classes that carry different fees, also called an “expense ratio.” They fall into two basic camps: “institutional” shares, which carry higher investment minimums and are generally available to employers and other institutions; and “retail” shares that carry lower minimums and are generally meant for individual investors.

Institutional shares generally have lower fees than retail shares.

The Pew study assumes a 401(k) saver invests in the institutional version of a mutual fund, while a rollover would be to the retail version of the fund. The study estimates how such a rollover might impact individual retirees in different circumstances.

In one example, a 65-year-old woman who retires with $250,000 in her 401(k) would end up with about $20,500 less in savings at age 90 due to higher IRA fund fees, given certain assumptions — a “significant loss for a person living on a fixed income,” the study said.

Those assumptions include: annual fees of 0.46% and 0.65% in a 401(k) and IRA, respectively; a 5% average annual rate of return; and account withdrawals of $1,000 a month to supplement Social Security benefits.

When you’re deciding whether to leave assets in a workplace retirement plan or roll them into an IRA, there are many factors to consider:

Cost. Fees won’t always be higher in an IRA relative to a 401(k) plan. Not all 401(k) plans use cheaper “institutional” shares. Many IRA funds may be cheaper than those in your workplace plan. Those who want to roll over should look for funds with equivalent or lower expenses relative to funds they owned in their 401(k), Pew said.Convenience. IRAs can serve as a central repository for all or most of your retirement funds, Scott said. People with multiple 401(k) accounts can roll all that money into one IRA, which may be easier for some savers to manage.Flexibility. Many 401(k) plans may not allow for as much flexibility around withdrawing money as retirees would like, either. For example, nearly 31% of 401(k) plans didn’t allow for partial or periodic withdrawals in 2020,according to the PCSA survey.Investment options. Overall, savers may benefit from leaving money in their 401(k) when they leave an employer if they’re happy with their investments, according to the report. But it’s also worth noting that your investment options in a 401(k) are limited to those your employer and plan administrator have selected. With an IRA, the menu is much broader. Certain retirement investments like annuities are largely unavailable to 401(k) savers, too.

“Certainly there are lots of situations in which a rollover would make sense,” Scott said.

“The rollover [itself] is not the problem,” he added. “It’s really understanding what the fees are.”