Many Americans are losing out on hundreds of billions in retirement savings due to a simple yet significant error in how they handle their IRA accounts.

This insight comes from a recent study by Vanguard, an investment firm, highlighting the poor performance of numerous individual retirement accounts.

The issue arises during rollovers, which is the process of transferring funds from an employer-sponsored retirement plan to a traditional IRA after leaving a job.

Analyzing IRA rollovers from 2015, Vanguard discovered that 28% of savers still had their funds sitting in cash seven years later, in 2022.

A single mistake costs investors $170 billion in retirement wealth

According to Vanguard, this oversight results in a staggering loss of at least $170 billion annually for investors’ retirement savings.

The issue is that when someone rolls over a 401(k) to an IRA, the funds often arrive in cash or a cash-equivalent account, like a money market fund. These types of accounts generally earn interest of less than 1% per year, although better rates are available.

To make their money grow again, the investor needs to log into their retirement account or make a phone call to reinvest in stock or bond markets.

If they neglect to do this and leave a rollover IRA sitting in cash, they could lose out on at least $130,000 by age 65, assuming the rollover occurs by age 55, according to Vanguard’s findings.

“Many investors incorrectly think that their funds will be automatically reinvested,” stated Andy Reed, head of investment behavior research at Vanguard.

“We’ve talked to many experts—people who hold PhDs—who have shared their own experiences with this mistake, and it has been astonishing,” he added.

Financial advisors report seeing rollover IRAs sitting in cash for years, leading to missed opportunities for thousands of dollars in compound interest.

Potentially a million dollars in lost savings: ‘I couldn’t believe it’

Michelle Crumm, a financial planner based in Ann Arbor, Michigan, recently started working with a new client in her mid-50s, who had once saved $200,000 in her 20s at a lucrative job.

“But that money has just been sitting in cash,” Crumm told her.

After some quick calculations, Crumm realized that with an 8% interest rate over 25 years, that $200,000 could have grown to over $1 million.

However, she decided not to mention that figure to her client, thinking it wouldn’t help. “I try to meet people where they are at. The past is the past,” she explained. “I’m sure I gasped.”

Financial advisers note that rarely does the finance world present such a straightforward and rewarding solution:

If you have an IRA, check your investment holdings. If they’re in cash or a money market account, think about reallocating them into stocks and bonds to maximize potential investment growth in the future.

“This isn’t a small amount of money we’re discussing. We’re talking about a significant amount,” highlighted Heather Winston, assistant vice president and head of product strategy at Principal Financial Group.

It may be hard to believe that millions of Americans have forgotten to invest billions in their retirement funds.

Investors typically wait 9 months to reinvest rollover funds

Vanguard’s study found that the average investor holds onto rollover funds for about nine months before reinvesting. Some may delay even longer. Young investors, specifically those aged 20 to 29, commonly let their IRA rollover funds remain in cash for a staggering seven years.

A survey by Vanguard revealed that many investors who left their IRA money as cash were unaware that these funds weren’t being invested at all.

Financial advisors agree with this observation.

Spenser Liszt, a certified financial planner from Dallas, shared, “I’ve encountered numerous clients who kept their funds in cash for extended periods, thinking that their account was automatically investing their money.”

Liz Windisch, a certified financial planner in Denver, noted she has repeatedly seen funds in IRAs stagnate in cash. “Some clients simply didn’t know their money wasn’t working for them, while others intended to take action but kept delaying it—often for years,” she explained.

Retirement accounts aim to motivate individuals to save for life after work.

Default positions in rollover IRAs often default to cash

Conventional advice suggests that most savings should be invested in stocks, expected to yield approximately 10% annually over the long run. Some investors also allocate a smaller portion to bonds, which typically generate lower returns but can protect against stock market fluctuations.

When enrolling in a 401(k), there is usually a default option that invests in a balanced mix of stocks and bonds, often tailored to the employee’s anticipated retirement date. This ensures that even if employees do not choose investments, their savings can still grow.

However, IRAs have different protocols. When someone leaves their job and transfers a 401(k) into an IRA, typically, the investments are sold off, and the money is placed into cash or a cash equivalent.

“Many investors overlook the crucial next step,” Reed added, “which is to reinvest that cash.”

The identical issue applies to contributions to IRAs. Vanguard’s research showed that a year after investors contributed to their IRAs, 12 months later, a large percentage of those funds were still cash.

Encouraging proactive financial help

Addressing this challenge seems straightforward: a financial advisor should inform retirement savers when their IRA cash becomes stagnant. Yet, this does not always occur.

“As an industry, we need to improve at saying, ‘We can assist you with this,’” stated Winston from Principal. “Financial firms must proactively offer guidance on what steps to take next.”

For instance, investment firms could identify IRAs that have remained in cash for over a year and send notifications to the account holders about the advantages of investing their funds.

A Vanguard representative mentioned that they have been actively helping IRA investors locate suitable investments for their cash by sending reminders and streamlining the reinvestment process.

This initiative may help explain the improvement witnessed by Vanguard regarding rollover cash management. For rollovers completed in 2022, only 28% of those accounts were still in cash after one year. By contrast, among rollovers from 2015, 28% stayed in cash even after seven years.

In a policy report, Vanguard encouraged legislators to modify IRA regulations to enable automatic investments of rollover funds. This means that if a saver neglects to take action, their funds would automatically be placed into a balanced portfolio of stocks and bonds.

“The presence of uninvested cash within retirement accounts is a critical issue that affects millions of Americans’ ability to save for retirement,” the report emphasizes. “A systematic resolution is essential.”