Here’s a pro tip that can hardly be said often enough.
When you change jobs and you think about rolling over your old company’s 401(k) to an IRA…watch out for all the extra fees.
“Thousands of dollars in savings can be lost over time because of what might seem like modest differences in fees between funds or between types of shares within a fund,” reports the Pew Charitable Trusts in a new study. “An analysis of fee differences shows that the routine shifting of billions of dollars each year from 401(k)s—which are often able to purchase lower-cost institutional shares—into IRAs in which savers frequently purchase retail shares can translate into significantly higher costs for retail investors, costs that can eat into their long-term savings significantly.”
Pew’s estimate suggests that the money rolled over from 401(k) plans to IRAs just during 2018 could have hiked savers’ fees by nearly $ 1 billion that year and over 25 years could lower those savers’ final retirement savings by more than $ 45 billion.
The reason is that when you are invested in mutual funds through your 401(k) you may be getting the equivalent of a group discount: You may be paying lower annual expenses on those funds, through a so-called “institutional” class of shares, than you would if you invested in them individually through an IRA.
There are, to be sure, some assumptions in these numbers that are worth looking at more closely. Pew highlights a “representative” midcap U.S. stock fund that charged fees as low as 0.74% a year for 401(k) plan members but as high as 1.86% for retail investors. That’s an astonishingly large leap.
It says that across the mutual-fund industry, institutional share classes available to 401(k) plans have much lower average expense ratios than “retail” classes you and I have to buy on our own. For instance, for stock market or equity mutual funds, they calculate the median expense ratio to be 0.90% of your assets per year, compared to 1.24% a year in retail shares. Among bond funds, the median institutional fund charges 0.55% a year, compared to 0.86% in the retail funds. In hybrid or balanced funds, which own stocks and bonds, the institutional shares have median expenses of 0.46% a year, compared to 0.65% a year for retail investors.
Over time, these differences can end up making massive differences through the power of compounding. Paying 1.24% a year in expenses in a stock fund, compared to 0.9%, can easily leave you with 10% less money by the time you retire.
Pew points out that it is often hard to find out exactly what fees you are paying in many funds.
But rollovers aren’t all bad news. Far from it. Done right they can be a big positive. One of the major gains is that you are likely to have many more investment choices in an IRA. Company 401(k) plans generally offer a very limited range of funds. It is a myth that all you need are U.S. stocks and bonds.
And you can drastically lower your fees instead of raising them. Paying 0.9% a year on your stock funds in your 401(k)? Frankly, I can’t imagine paying that much for a retail fund, even if it invested in obscure stocks in far-away countries. Let alone for a U.S. stock fund.
Check out all the low cost funds, mostly index funds, charging 0.1% or less. Vanguard’s S&P 500 ETF VOO, +0.18%, charges 0.03%. Fidelity’s ZERO Total Market Index Fund FZROX, +0.37% charges nothing at all.
Based on the same assumptions, one of those funds could easily leave you with 25% more money in your pension pot when you retire than an institutional fund charging you 0.90%.
Rollovers can be very good for your wealth. But you need to do your homework. No one else is going to do it for you. And watch out for those fees.