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Understanding the Mistakes in IRA Rollovers: Unintentional Cash Holding

Many investors unintentionally land in a costly blunder while transferring their funds from a 401(k) to an individual retirement account (IRA). The common mistake to avoid: leaving their money as cash in the IRA.

Frequency of Rollovers and Cash Holding

IRA rollovers from workplace retirements are a common practice, especially when changing jobs or retiring. In 2020 alone, about 5.7 million people rolled a total of $618 billion to IRAs, as per the latest IRS data. However, a significant number of these investors end up leaving their moved funds in cash for a period ranging from months to years, leading to a phenomenon referred to as “cash languish” in recent Vanguard analysis.

Unintentional Cash Holding in IRA Rollovers

Surprisingly, about two-thirds of investors holding cash in their rollovers do so unintentionally. A Vanguard survey reveals that 68% of these investors are not aware of how their assets are invested, while 35% prefer cash-like investment. Vanguard surveyed 556 investors who completed a rollover to a Vanguard IRA in 2023 and left those assets in a money market fund through June 2024. “IRA cash is a billion-dollar blind spot,” Andy Reed, head of investor behavior research at Vanguard, said.

Retirement System’s Role in Unintentional Cash Holding

The retirement system itself contributes to this issue. For instance, when a 401(k) investor rolls their funds from an S&P 500 stock index fund to an IRA, the received money doesn’t automatically get invested in an S&P 500 fund. The account owner has to actively decide to move the money out of cash. As Philip Chao, a certified financial planner, puts it, “It always turns into cash. It sits there in cash until you do something.”

The Misconception about Automatic Investment

According to Vanguard’s survey, about 48% of people incorrectly believed that their rollover was automatically invested.

Problems with Long-Term Cash Holding

While holding cash in high-yield savings accounts, CDs, or money market funds is a sensible strategy for building an emergency fund or saving for short-term needs like a house down payment, it can be problematic for long-term savings. Investors often feel that they are safeguarding their retirement savings from the unpredictability of the stock and bond markets by saving in cash; however, advisors warn against this. The returns on cash holdings may be too insignificant to keep up with inflation over many years and likely won’t be enough to generate a substantial nest egg for retirement.

Repositioning Excess Cash

“99% of the time, unless you’re ready to retire, putting any meaningful money in cash for the long term is a mistake,” Chao said. He recommends using cash as a “temporary parking place” while deciding on a rollover investment. But, he warns, “most people end up forgetting about it, and it sits there for years, decades, in cash, which is absolutely crazy.” With the expected round of interest-rate cuts by the U.S. Federal Reserve, investors are advised to “start repositioning excess cash,” as stated by Tony Miano, an investment strategy analyst at the Wells Fargo Investment Institute.

Reevaluating the Need for Rollovers

Investors also need to reconsider the necessity of rolling money from their 401(k) plan to an IRA, as there are many factors to consider.

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The title for this article could be “Avoiding Unintentional Cash Holding in IRA Rollovers: A Comprehensive Guide”. The meta description could be “Learn about the common mistakes investors make when transferring funds from a 401(k) to an individual retirement account (IRA). Discover why unintentional cash holding in IRAs could be a costly error and how to avoid it.”

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