Americans change jobs a lot — more than a dozen times over a career.
A new opportunity beckons, across town or across the country. Cake is consumed and co-workers hand you a card scrawled with cheerful goodbyes. Your boss says she’ll miss you but wishes you well.
And that’s it. Except there’s one more thing you should do before the hustle and bustle of moving to your new job begins. Immediately open an IRA.
Why an IRA? Simple. It’s a low-cost way to save a lot of money for retirement.
Individual retirement accounts have been around since 1974. The idea is to give people a way to maintain the tax breaks of a former employer’s retirement plan. If your next job doesn’t have a 401(k), no problem — contribute to an IRA in your own name instead.
You could choose instead to roll your old 401(k) into a new plan at your next job. The problem with that idea is that most 401(k) plans are unnecessarily expensive. BrightScope, a company which analyzes 401(k) plans, found that people at small firms paid twice as much as people at large firms for their 401(k) plan.
For instance, a person with $50,000 in a 401(k) with a plan fee of 2% pays $1,000 a year. In comparison, a plan fee of 1% — typical at large companies — costs that person just $500 a year.
As your retirement plan balance goes up over time, so does your cost of being in the plan. A near-retiree with $250,000 in a high-fee 401(k) plan shells out $5,000 a year for exactly the same service as a first-year associate.
Opening an IRA and rolling over your 401(k) balance allows you to dramatically reduce your costs. Instead of paying a plan administrator at your old job, you get an IRA in your name at a brokerage firm such as Fidelity or Schwab. Once you’re in, account fees fall to zero.
Increasingly, too, it’s easy to invest using very low-cost index funds instead of pricey 401(k) mutual funds. Lower fees means thousands of dollars a year staying in your account and growing for you.
Just as money grows with compounding, so does the impact of fees. If you invested $100,000 one time and left it for 20 years at a market return, you should expect a balance of just over $400,000 at the end of that period.
Pay a 2% fee and your end balance would be a little more than $275,000 instead. Which figure would you rather see on your retirement statement, $400,000 or $275,000?
So where did the rest of your money go? To the 401(k) administrators and the fund managers, that’s where.
Unsurprisingly, most 401(k) plans make it incredibly hard to estimate their “all in” costs. There are fees from the plan itself, fees for mutual funds inside the plan, then more fees nested inside those funds.
A secure retirement
If you have access to a 401(k), that’s great. You get automated saving and investing, a great tax break now, and, in most companies, free matching funds from your employer. As long as you work there and get the matching money, go ahead and take advantage of these benefits.
Yet Americans now have $8.8 trillion stashed in IRAs, roughly a third of all retirement assets. An astounding 84% of new IRAs were opened with money rolled over from workplace plans. The reason is lower costs.
If your company is small or even medium-size, chances are you pay too much for your retirement plan. A self-directed IRA could help you secure tens of thousands of dollars more for retirement.
On your last day of work at your soon-to-be old job, march straight to human resources and ask for IRA rollover instructions in writing. Your future, retired self will thank you.
This article was originally published by MarketWatch on Oct. 29, 2019.