August 3, 2013
By Carolyn T. Geer

Retirement plans known as 401(k)s get lots of attention. But did you know there’s more money in individual retirement accounts? A lot more.

IRAs are now the biggest repositories of private-sector retirement savings in the U.S., with $5.4 trillion in assets, versus $4.1 trillion in so-called defined-contribution plans, which include employer-sponsored 401(k)s.

IRAs also have fewer investor protections, their fees can be higher, and returns lower. So you need to be especially vigilant when setting up and monitoring these accounts.


The main reason IRAs have surpassed 401(k)s in assets is that investors typically roll over their 401(k) balances to IRAs when they switch jobs or retire.

All this rollover activity is “extraordinary” given that investors tend to be passive participants in their 401(k)s, for example, rarely adjusting the amounts they contribute to their accounts, notes Alicia Munnell, director of the Center for Retirement Research at Boston College.

To be sure, there can be good reasons for choosing an IRA, particularly if the alternative is a small-company 401(k) plan with higher fees or poorer investment choices. But in a paper she wrote earlier this year, Ms. Munnell suggests there may be other motivating factors at work, such as seductive sales pitches from brokerage firms.

Indeed, there is some evidence that the system is effectively rigged in favor of distributions from 401(k)s to IRAs. Employers aren’t required to let departing employees with 401(k) balances under $5,000 leave the money in the plan. Nor are they required to accept rollovers from previous 401(k) plans. Those that do sometimes impose discouragingly long waiting periods on new employees wishing to enroll. Meanwhile, call-center representatives of the investment firms that manage 401(k)s often encourage departing employees to roll their 401(k)s into IRAs at their firms, “even with only minimal knowledge of a caller’s financial situation,” according to a recent report by the U.S. Government Accountability Office.


Ms. Munnell worries that investors assume the firms pushing IRA rollovers are acting in investors’ best interests, when many broker-dealers face incentives to sell high-fee investments, setting up a conflict of interest. By contrast, employers sponsoring 401(k) plans are duty-bound to act solely in employees’ interests.

More recently, the Financial Industry Regulatory Authority expressed concern that some IRAs are being misleadingly marketed as “free” or “no-fee.”

Some firms imply there are no fees charged to investors when there may be fees for opening, maintaining or closing accounts, in addition to brokerage commissions, investment-management fees or other marketing fees, the independent regulator wrote in a notice to U.S. securities firms last month.

Fees, of course, can greatly impact your account balance at retirement. An additional 1% per year in fees over 40 years would cut final assets by about one-fifth, according to an estimate by Ms. Munnell.

‘Yard Sale’

After fees, the second-biggest problem with IRAs today is the way the money in the accounts is invested, says Mitch Tuchman, who in January launched Rebalance, an independent investment advisory service that specializes in managing IRAs.

“Usually when we encounter these portfolios they’re a complete yard sale,” with a mishmash of stocks and funds investors have collected over the years, he says.

Rebalance typically reinvests the accounts in a mix of low-cost exchange-traded funds better aligned with each investor’s time horizon and appetite for risk, Mr. Tuchman says.

The situation is similar over at Financial Engines, an independent investment advisory firm that has been managing money in 401(k) accounts for nearly 10 years, and in May expanded its services to include IRA management.

“The quality of the IRA portfolios we see coming in varies dramatically, but on the whole it is worse than what we see in the 401(k) world,” says Chris Jones, the company’s chief investment officer. A great many IRAs are “poorly allocated” among “extremely expensive” funds, he says.

Make sure yours is not one of them.