When employees decide to leave their employer-sponsored retirement plan, either through retirement or a job change, many decide to roll their savings over into an individual retirement account. A recent study suggests that this can be a risky move financially, as IRA owners are more likely to face higher costs over time.

According to a Pew issue brief, “Small Differences in Mutual Fund Fees Can Cut Billions From Americans’ Retirement Savings,” when an individual moves their savings over into an IRA, thousands of dollars in savings can be lost over time—simply because of differences in fees between funds or between types of shares within a fund.

As the analysis details, mutual funds have share classes that charge different fees depending on the type of investor. Shares held by individuals using their own savings outside of the employment context—i.e., retail investors—tend to carry higher fees than institutionally priced shares delivered at scale to large populations of retirement plan participants.

Unlike most individual investors, employer-sponsored retirement plans can leverage their purchasing power to access lower fee shares. Accordingly, the study shows, the routine shifting of billions of dollars each year from 401(k)s into IRAs can translate into higher costs for retail investors, which eats into their long-term savings.

IRAs offer a way for those without access to an employer-sponsored plan to save, but only 13% of working Americans use these accounts to put away money for retirement, the study says. From 2009 to 2018, rollovers from employer-sponsored retirement plans accounted for more than 95% of traditional IRA inflows each year.

In 2018, investors rolled $516.7 billion from employer retirement plans into traditional IRAs, the study says. Looking at the difference in fees and using a hypothetical retirement period of 25 years, those retail investors could see an aggregate reduction in savings of about $45.5 billion—all thanks to the single rollover decision.  

In 2020, about 57% of households with IRAs indicated that the balance included rollover assets, and of those who completed rollovers, 56% reported that those assets constituted their entire IRA balance, the study states.

To highlight the impact individual investors face, the study examines the differences between institutional and retail class annual expenses across all mutual funds that offered at least one institutional and one retail share in 2019.

For mutual funds that primarily hold equities, costs are significantly higher for retail shares, the study says. Annual expenses for median retail shares were 0.34 percentage points higher than those for institutional shares—representing about 37% higher fees.

Mutual funds that hold both equities and bonds—known as hybrid funds—and bond mutual funds have lower expenses than equity funds do, the study states. Median retail share expenses are about 41% higher for hybrid funds and 56% higher for bond funds compared with median institutional share expenses.

To illustrate how the differences in expenses can affect savings, the study uses three hypothetical investors, finding a reduction in savings of between nearly $21,000 and $138,000 after 25 years. The differences may appear small at first glance, but in each example, a substantial loss of savings accrued over time. Even small disparities in fees can lead to big differences in retirement savings account assets, the study shows, given that the accounts are often used for decades to accumulate savings.

The study also mentions a 2013 report from the Government Accountability Office on IRA rollovers and the confusion they can cause, which found that the information that plan participants receive upon separation is often insufficient or overly technical in nature. People leaving workplace plans often receive advice or marketing from financial firms favoring IRAs, and they may interpret this information as a tacit suggestion to choose providers’ retail investments.

Given the troubling data, more plan sponsors are seeking ways to retain retirees in their plans, the study states, so that all participants benefit from the lower investment costs that come with economies of scale.

Importantly, employer-sponsored retirement plans and IRAs both make high- and low-cost funds available to investors, meaning IRAs are not inevitably more expensive. Still, on average, the institutional share classes of mutual funds available in an employer plan are less expensive to own than the same fund’s retail share classes.

The study suggests that savers who are happy with their investments may be better off leaving their assets in the plan when they separate from their employer. Those who want to complete a rollover should seek investments with equivalent or lower expenses than the mutual funds they owned in their 401(k).

To accomplish this, the study suggests, investors should be provided with clear, accessible information about fees. In addition, employers may want to enhance financial wellness programs with online or other services that help retirees and others leaving their jobs make good decisions with their retirement savings.