Avoiding Costly IRA Mistakes: What You Need to Know Before Rolling Over Your 401(k)

Written By: Alex Hammersley, CPA

Rolling over a 401(k) into an IRA is a common step many Americans take as they move jobs or approach retirement. It can be a smart financial move, offering more control over your investments, greater flexibility, and often lower fees. However, there is one mistake that many investors make during the rollover process, and it’s costing them billions of dollars each year in lost retirement savings.

According to research from Vanguard, more than 1-in-4 investors leave their rollover funds in cash for years after the transfer is complete. In fact, the study found that 28% of IRA rollovers completed in 2015 still had their funds sitting in cash seven years later. This oversight results in an estimated $170 billion in lost retirement wealth annually.¹

Why Leaving Funds in Cash is Costly

When funds from a 401(k) are rolled over into an IRA, they often arrive in the form of cash or a cash-equivalent account, like a money market fund. While cash may seem like a safe option, it usually offers very low interest rates, often less than 1% per year. This rate of return isn’t enough to keep pace with inflation, and it certainly won’t provide the growth necessary to support a comfortable retirement.

Leaving funds in cash over long periods can be devastating for your financial future. Vanguard estimates that an individual who rolls over their 401(k) into an IRA at age 55 and leaves it in cash could lose out on as much as $130,000 in potential retirement wealth by the time they turn 65. That’s a significant amount of money that could otherwise be growing in a diversified portfolio of stocks, bonds, and other assets.

Why Do So Many People Leave Their Money in Cash?

The most common reason for this mistake is simply a lack of awareness. Many investors don’t realize that their rollover funds need to be actively reinvested once they land in the IRA. There’s a common misconception that the funds are automatically invested upon transfer, but this isn’t the case. Investors need to log into their account or contact their advisor to allocate those funds into new investments.

Another factor is the “out of sight, out of mind” mentality. After completing the rollover, people may assume their job is done and neglect to revisit their account. The result? Their money stays parked in cash, not working as hard for them as it should.

It’s Not Just Novice Investors

You might think this is a mistake only made by those new to investing, but the data tells a different story. Vanguard’s research found that many of the investors leaving their funds in cash were actually knowledgeable about the markets. For instance, 77% knew that mutual funds are generally less risky than individual stocks, and 71% understood that money market accounts are conservative investments. Despite this knowledge, nearly 50% of these investors mistakenly believed that their IRA contributions were automatically invested, and many didn’t realize that money market accounts were the default setting for their rollover.

How to Avoid This Costly Mistake

The good news is that this is an easily avoidable error. Here’s how you can make sure your rollover works for you:

Take Action Immediately: After completing a 401(k) rollover, check your IRA account as soon as possible. If your funds are sitting in cash, take the time to reinvest them in a diversified portfolio. The sooner you put your money back to work, the more you’ll benefit from the power of compound growth.
Know the Process: Be aware that when you roll over your 401(k) to an IRA, the funds will not be automatically invested. It’s your responsibility to select the investments that align with your retirement goals.
Consult a Professional: If you’re unsure how to best allocate your rollover funds, consider working with a financial advisor (like us!). We can help you create a tailored investment strategy that maximizes your potential returns while managing risk.
Review Your Portfolio Regularly: Once your rollover is complete and your funds are invested, don’t set it and forget it. Review your portfolio periodically to ensure your investments are still aligned with your financial goals and risk tolerance.

The Bottom Line

Rolling over a 401(k) into an IRA can provide you with greater flexibility and control over your retirement savings. However, failing to reinvest your rollover funds can be a costly mistake. By staying proactive, understanding the process, and seeking guidance if necessary, you can avoid the pitfalls that have caused so many others to lose out on valuable retirement wealth.

Take control of your financial future by ensuring your money is always working for you, not sitting idle in cash.