The financial pitfalls of leaving cash in your IRA rollovers

When you leave a job or retire, rolling over your 401(k) into an Individual Retirement Account (IRA) can provide greater control over your retirement savings. However, a critical mistake many people make is leaving their rollover funds in cash. This seemingly safe choice can lead to significant financial losses over time.

A study by Vanguard revealed that in 2015, 28% of workers who rolled over their 401(k) into IRAs left their savings in cash for more than seven years. This inaction can result in missed investment opportunities and substantial financial losses. Vanguard's research highlights that younger investors, women, and individuals with smaller balances are more likely to leave their money uninvested.

Why Investing Your Rollover Funds Matters

When you roll over your 401(k) into an IRA, your funds are not automatically invested in the market. This means that unless you take action, your money could sit idle in cash, missing out on potential growth. Priya Malani, founder of Stash Wealth, emphasizes the importance of investing these funds to take advantage of more investment options and lower expense ratios compared to 401(k) plans.

Preston Cherry, founder of Concurrent Financial Planning, also advocates for rolling over 401(k) funds into an IRA to consolidate accounts and simplify money management. However, both experts stress the importance of ensuring that the rollover funds are actively invested to maximize growth potential.

The Cost of Leaving Money in Cash

Leaving your rollover funds in cash can lead to significant financial losses. For instance, Vanguard estimates that for investors under 55, rolling the money into a target-date fund could result in an increase of at least $130,000 by age 65. Target-date funds automatically adjust the investment mix to become more conservative as you approach retirement, offering a balanced approach to growth and risk management.

"Whatever you do, don't leave it in cash, and unless you are very close to retirement," Malani advises. "Don't invest it conservatively or you'll be unnecessarily giving up growth potential and missing out on that valuable concept called compounding".

Benefits of Rolling Over to an IRA

Rolling over your 401(k) to an IRA offers several advantages:

More Investment Options: Unlike 401(k) plans, which typically offer a limited selection of funds, IRAs provide access to a wide range of investment options, including stocks, bonds, ETFs, mutual funds, and even cryptocurrencies.

Lower Fees: IRAs often have lower expense ratios compared to 401(k) plans, which can lead to higher net returns over time. Many IRA providers have eliminated commission fees and offer low-cost index fund ETFs and no-load mutual funds.

Consolidation: Rolling over multiple 401(k) accounts into a single IRA simplifies recordkeeping and makes it easier to manage your overall retirement portfolio.

Potential Drawbacks

While rolling over to an IRA has many benefits, it's essential to be aware of potential drawbacks:

Creditor Protection: 401(k) plans generally offer better protection against creditors compared to IRAs, which may vary by state laws.

Access to Funds: 401(k) plans may allow penalty-free withdrawals under specific circumstances, such as separation from service after age 55, which is not available with IRAs until age 59½.

Expert Recommendations

To avoid the financial pitfalls of leaving your rollover funds in cash, experts recommend:

Investing Promptly: Ensure that your rollover funds are invested as soon as possible to take advantage of market growth.

Seeking Financial Advice: Consult with a financial advisor to determine the best investment strategy for your retirement goals.

Diversifying Investments: Consider target-date funds or other diversified investment options to balance growth and risk.

Rolling over your 401(k) into an IRA can provide greater control and more investment options, but it's crucial to invest the funds promptly. Leaving money in cash can result in significant financial losses and missed opportunities for growth. By taking a proactive approach and seeking professional advice, you can maximize the potential of your retirement savings and secure a financially stable future.