The most common qualified retirement plan transaction is the rollover. Quite often when an employee leaves an employer, the employee rolls over the 401(k) or other retirement plan balance to an IRA.
These rollovers could be costing many investors thousands of dollars, according to a new study from Pew Charitable Trusts.
Many 401(k) and other employer retirement plans allow participants to buy “institutional shares” in mutual funds and other investment funds. These shares have lower expenses and fees than the standard “retail shares” of the funds.
An individual can purchase institutional shares through an IRA, but only when the individual has a significant IRA balance. Most institutional share classes have a minimum initial investment of $1 million. Most people, after rolling over money from an employer plan to an IRA, have to buy the retail shares.
The cost difference between the two share classes might seem very small, but the total additional cost mounts over time. Hybrid mutual funds (typically balanced or asset allocation funds) had the lowest cost difference between retail and institutional shares at 0.19 percentage points.
Even that small difference compounds to a big number. The Pew study said that many investors don’t realize how much the shift from institutional shares to retail shares costs them over time.
Using the total amount rolled over from IRAs to 401(k)s in 2019, the expense difference cost investors a total of $980 million in that one year alone, according to estimates in the study. Stock and bond funds have more significant cost differences between the two share classes, so the loss to investors is much higher.
Over periods of 25 years or more, the cost really compounds. One estimate in the study is that after 25 years an investor who rolled over $250,000 would have paid more than $10,000 in additional fees. The final balance of the account would be reduced by more than $20,000.
The study recommends what I’ve long recommended. Before rolling over money from an employer plan to an IRA, compare several factors. One factor is the quality of the investment options in the 401(k) and IRA. Another factor is the fees and expenses charged by each of the options. Some employer plans have average to high fees, while others work hard to reduce the costs to their participants and are good deals.
Don’t automatically roll over a 401(k) to an IRA when leaving an employer. Consider all the differences between the two options.