Individual retirement accounts (or IRAs) are America's most popular retirement account. Nearly 40% of Americans have one. According to Alicia Munnell (director of the Center for Retirement Research at Boston College), these accounts had $13.5 trillion in total assets as of last year.
According to a Pew analysis, these would-be retirees can lose billions of dollars due to high IRA fees.
Pew found that even small fees can add up to large losses over time. This is especially true for retirees who live on fixed incomes. A reduction in the potential retirement savings of a worker can have a lasting impact on their standard-of-living in retirement.
The report concluded that "in the aggregate, it is possible for retirement savings to be lost in such rollovers to reach tens or billions of dollars."
Workers who leave their jobs and transfer assets from their previous 401(k), are the main drivers of IRA investments.
There are many options for someone who leaves a job that has a 401(k).
Many people love IRAs for their convenience in tracking their retirement savings and being able to choose from a variety of investment options. A government watchdog discovered that IRAs are heavily promoted by financial institutions in 2013.
The Government Accountability Office discovered that institutions steer workers into IRAs without fully understanding their particular circumstances. Workers may not be aware that they are being sold a product.
Investors can be stuck with higher fees for an IRA, even if the underlying investment product remains the same, Pew research shows.
What's called share classes is what makes the difference. There are many types of mutual fund shares. These classes can be aimed at institutional investors or individual investors.
All classes of shares can be invested in the same investment basket -- stocks, bonds and real estate, but different classes might offer different features or services, or have different marketing and administration costs.
Institutional shares, a type of mutual fund share that is only available to institutions, typically require a high minimum investment, often $100,000. This makes them only available to wealthy individuals or employers who pool individual contributions. These share classes pay the lowest fees because institutional investors have more money.
Retail shares are for individuals, and they have minimums that can be as low or even zero. Retail share classes can charge higher management fees than investors classes, which leads to a loss that continues over time.
Many investors might not be aware that they are being charged higher fees. Pew says that fee disclosures for these accounts are technical and difficult to comprehend. These disclosures, which are often ignored, are similar to the terms and conditions of many online accounts.
Pew discovered that fee differences can be substantial.
Pew found that stock-based investment funds have 37% more expenses than those for institutional investors. However, the median expense for bond-based funds is 56%.
Hybrid funds that invest in both bonds and stocks have the lowest expenses. The typical hybrid fund charges 31% more for retail investors. However, this is still a significant upcharge.
Because fees decrease the amount of retirement savings that can grow and compound over time, they can lead to lost retirement savings of tens or thousands of dollars.
Pew states that while the differences may seem small at first, they can have a significant impact on savings over time.
Pew provides an example: A 65-year-old worker with a large 401(k balance of $250,000 retires and transfers it into an IRA. After 25 years, her income would be $20,513 lower due to higher fees in an IRA.
Mid-career worker could lose a lot more if they move the same $250,000 balance from a low cost 401(k), to a high-cost IRA. The account balance would be $137,630 less after 25 years.
Pew points out that higher fees can erode future gains and the magnitude of savings lost is greater than the fee increase.
A worker in early career who transfers $30,000 from a 401k into an IRA would see a $64,000 decrease in the balance. This is because of higher IRA costs over 40 years.
Pew suggests that employers assist workers who are leaving to save their retirement savings by offering 401(k), rollovers. This allows them to keep their 401 (k)s the same as they were or helps them resist high-fee financial products.