WSJ Your Money Briefing - The 401(k) Rollover Misstep That Could Cost You

Episode Date: July 30, 2024

When people change jobs, their 401(k) retirement funds often wind up in individual retirement accounts, or IRAs. Wall Street Journal reporter Anne Tergesen joins host J.R. Whalen to discuss misunderstandings about the rollover process that can limit savers’ potential for growth. Sign up for the WSJ's free Markets A.M. newsletter.  Learn more about your ad choices. Visit megaphone.fm/adchoices

Shop Best Buy's Ultimate Smartphone Sale today. Get a Best Buy gift card of up to $200 on select phone activations with major carriers. Visit your nearest Best Buy store today. Terms and conditions apply. Here's your Money Briefing for Tuesday, July 30th. I'm J.R. Whelan for The Wall Street Journal. Thursday, July 30th. I'm J.R. Whelan for The Wall Street Journal. When they change jobs, many people choose to roll over their 401k retirement savings into an individual retirement account, or IRA. But then, they don't follow through. A lot of people, especially those who are younger, who have benefited from automatic

enrollment and 401k plans, they assume that IRAs work the same and that they might realize, okay, I have to transfer that money. But once it's in the account, it will be automatically invested for me. And it's not. It's going to stay in cash. And that means they can miss out on significant growth. Wall Street Journal retirement reporter Ann Turgason will talk about how to make sure your retirement savings don't miss a beat. After the break. Wherever you're going, you better believe American Express will be right there with you. Heading for adventure? We'll help you breeze through security.

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A critical mistake people often make when rolling over their retirement savings can cost them substantial gains. Wall Street Journal personal finance reporter Ann Turgason joins me. Ann, bring us up to speed for a moment. What options do people have with their retirement account when they leave a company? You basically have three options. The first one is just to leave the money at the company and, you know, not to get too in the weeds, but if you have a very small account, that may not be possible. But generally, if your account is worth more than $7,000 of your balances, you will have the option to leave that money with your former employer.

You should check with your former employer on that. But that usually is an option, and it can be a very attractive one. If you're in one of these mega 401k plans that has ultra ultra low fees, that can be a great option for you. The second option is to roll the money over to your new employer's 401k plan. So basically by rolling it over, what I mean is you transfer it without any tax consequences. And the third option is to roll it over to an IRA. Does people's money automatically go with them when they change jobs? No, no. You have to do something. If you don't do anything, it's money automatically go with them when they change jobs? No, no. You have to do something. If you don't do anything, it's going to stay with your former employer.

Again, if it's a pretty small balance, if it's less than $7,000, the employer has the option to roll that out for you into an IRA. So it's sort of an involuntary IRA rollover. So that can happen if it's a small account. But basically, if your balance is above $7,000 and you do nothing, your account's just going to stay at your former employer's 401k plan. If people do want to rollover their savings to the new job location, what steps should they take? The rollover process can really vary depending on which company has your IRA and which company has your 401k. The basic steps are that you need to, if you don't have an IRA already, you need to open one. So you need to call up whatever company that you want to house your IRA

and you need to open up one of those accounts. And that could be a company like Fidelity or something like that? Yeah, Fidelity, Schwab, Vanguard, those are some of the bigger ones. And then you need to contact your 401k provider and you need to say that you want to do a rollover and they will walk you through the steps that are involved. But you're right that as part of the rollover process, some people make a mistake that can actually cost them quite a bit of money. How so? What happens is that people will initiate the rollover and they'll think once they deposit the check into the IRA and they think that's it, that they're done. But they're not because you have to wait then for the money to go into the IRA. You have to wait for that check to clear and that can take a couple of days, and then you have to go back in and decide

how you want to actually invest that money. A lot of people think, oh, I sent the check, the money's in the account, I'm done. Yeah, sounds like a lot of confusion or misconceptions out there. What others have you heard of? When so many people, especially younger workers, have been automatically enrolled in 401k accounts. The way it works with 401ks is that if your employer automatically enrolls new hires, you don't have to do anything. You're just automatically put into the 401k plan. They start deducting money from your paycheck.

It automatically goes into what's called a target date fund, which is a diversified stock and bond fund. The new worker gets into the 401k plan. Sometimes they don't even know it. It just all happens seamlessly, automatically, and they're automatically invested in the stock and bond markets. So a lot of people, especially those who are younger, who have benefited from automatic enrollment and 401k plans, they assume that IRAs work the same and that they might realize, okay, I have to transfer that money. But once it's in the account, it will be automatically invested for me. And it's not.

It's going to stay in cash. Sometimes people believe mistakenly that the company administering the IRA or 401k will make recommendations or just set up their money to do the best thing for them. But it's actually up to the user to do that. Right. It's a different situation. The fiduciary there is the account owner. The account owner is supposed to make the investment decisions. But there is no entity on the IRA side that has that legal authority to auto-enroll you other than you yourself. You spoke with a financial advisor in Maine who's worked with clients who made

mistakes like the ones we've spoken about. What did she tell you? She talked about a client of hers who, before they hired her, they rolled over a pretty large 401k to an IRA. And they didn't realize it, but they were sitting in cash in that account. Well, in 2020, if you think back on it, the returns on cash were incredibly low, not even 1%, right? So this money, very large sum of money, these people are getting ready to retire, it's sitting in cash. And then they hired her, but they had lost out on a full year's worth of stock market gains. And that happened to have been a year that the stock market

did incredibly well. So I think it was very costly for them. That bounce back from the pandemic, they missed. Yeah, they missed out on that. Yeah. So unfortunately, I mean, you know, one thing to point out here is that the cost of sitting in cash is not nearly as high as it used to be. I mean, now with money markets around 5% in terms of the interest that they pay, that's much higher than zero, which is where we were a couple years ago. However, people will point out that especially for younger investors and even for older investors, it's important to have some exposure to stocks because historically, stocks have returned north of 7% a year on average, and that's after inflation. There's no substitute for having stock market exposure for long-term growth.

So particularly for younger investors, but also for people who are getting ready to retire, who maybe are facing a 30-year retirement, there's still a strong argument that at least some money should be in the stock market for growth. This idea of rolling over and sitting in cash is a little less costly now, but it still isn't necessarily optimal for most people. So somebody who's listening who realizes, oh my goodness, I need to go in and take a look at my IRA or 401k and sort this out and make some changes, how do they do that? It's very easy. You just pretty much go online. Most people have online accounts. If you don't, you can set that up and then you just look

and see where it's invested. You can direct the provider to purchase X number of shares of whatever you want to buy. I think the hard part for people is that with 401ks, there's usually a pretty limited investment menu. In fact, maybe a dozen choices typically, maybe 20 at most. But in the IRA world, there are thousands. So for people who are confronted by thousands of choices and they don't know what they need, what they want, they don't really know much about investing, that can be kind of overwhelming too. So I think in that case, it's helpful to get some advice. There are advisors who will do sort of a one-time consultation for people, but in terms of the actual transaction and sort of going into your IRA online and looking to see

what it's invested in and then redirecting that into other stock and bond investments, that's actually pretty easy to do once you know what you want to invest in. That's WSJ reporter Anne Turgason, and that's it for your Money Briefing. This episode was produced by Ariana Osborough with Deputy Editor Chris Zinsley. I'm J.R. Whelan for The Wall Street Journal. Thanks for listening.