Over the past decade or two, the pace at which we change jobs has increased dramatically. Matter of fact, a recent study found that, on average, today’s workers will change jobs twelve times in their lives.¹ So, every three or four years, chances are you’ll need to decide what to do with the money you’ve saved in your current 401(k) account.

However, in the middle of these job transitions, you have many priorities and pressing needs to address. As a result, the company retirement plan from your former employer is often overlooked. The easiest thing to do is often leave your old 401(k) account behind. Subsequently, these plans are often forgotten about or ignored … becoming what I refer to as Zombie 401(k)s!

Just how big is this problem? Thanks to a recent study on forgotten 401(k) accounts conducted by Capitalize² we now know how large and costly the Zombie 401(k) problem really is:

• As of May 2021, Capitalize estimates there are as many as 24.3 million Zombie 401(k) accounts in the US.

• These Zombie 401(k) accounts total approximately $1.35 trillion of assets, representing about 20% of the estimated $6.7 trillion of assets invested in 401(k) plans.

• Each year, another $2.8 million old 401(k) accounts are forgotten or left behind.

• Worst of all, leaving behind a string of Zombie 401(k) accounts could cost you almost $700,000 in foregone retirement savings compared to consolidating them into a single low-fee optimally allocated retirement account – whether it’s your new employer’s 401(k) plan or a Rollover IRA.

Leaving $700,000 on the table may sound a little far-fetched, at first. So, let’s dive into that number and examine just how costly your Zombie 401(k)s might be.

As of May 2021, Capitalize estimates the average Zombie 401(k) balance is $55,400 based on their analysis and data from the department of labor, 401(k) recordkeepers, and the Census Bureau.

The study highlighted the significant risk of missing out on asset growth by forgetting savings in a forgotten Zombie 401(k) that is not optimized. There are two key components in the estimated $700,000 of forgone retirement savings:

• The risk of higher fees: the risk of a Zombie 401(k) account being help in one of the many high-fee 401(k) plans that still exist.

• The risk of lower returns: the risk that a Zombie 401(k) account is invested in a low-return investment vehicle like a money market mutual fund (MMMF) or stable value fund rather than a diversified portfolio of higher-returning investments.

Let’s look at each of these problems in a little more detail.

All Those Fees Add Up

The problem begins with the fact that many 401(k) participants incorrectly assume that their accounts are fee-free. In reality, 401(k) participants are often charged fees that are tied to the level of assets in their plan. These fees have two principal components:

• The individual investment fees that are charged for each of the mutual funds or exchange-traded funds (ETFs) held you the account. These fees are known as “expense ratios.” The expense ratio on various ETFs and mutual funds can vary greatly. Expense ratios tend the best the largest fees paid by 401(k) participants.

•  Investment management and administrative fees are paid to offset the cost of recordkeeping and management of the plan.

Although employers can elect to pay some or all of these fees themselves, most of the time a significant portion of these fees are passed along to the participants. So, participants are on the hook for most, if not all, of these fees.

Unfortunately, the fees on Zombie 401(k)s can be substantial. In 2020 an Investment Company Institute found that the median annual 401(k) fee is 0.85% of assets. That figure is even higher for some of the worst 401(k) plans. The study found that the bottom 10% of plans had expenses of 1.48% or more … with the worst plans exceeding 2%.³

That stands in stark contrast to some of the best 401(k) plans. Plans ranking in the top 10% often sport expenses of 0.41% or less.

Annual account fees as a percentage of assets

That difference in fees between a high-fee Zombie 401(k) and a low-free retirement account, be it an IRA or another 401(k) plan, can be dramatic. For an account with a balance of $50,000

• In a low-fee IRA or 401(k) plan charging 0.40%, an account holder will pay only $200 in fees per year.

• In a middle-of-the-road 401(k) plan charging 0.85%, an account holder will pay $425 in fees per year … more than double the low-fee account.

• In a 401(k) charging 1.50%, an account holder will pay $750 in fees per year … almost four times that of the low-fee account.

With 401(k) plan fees slowly dropping, the number of participants suffering from fees of 1.50% or worse is declining, but still significant. What this means is that your Zombie 401(k) may very well be sitting in a high-fee 401(k) resulting in greater fee expenses over time.

The Negative Impact of Stale or Sub-Optimal Asset Allocation

Think zombies are scary? Here’s an even more scary statistic. A well-allocated 401(k) could outperform a poorly allocated forgotten 401(k) by over 900% in a single year! And that difference continues to rise, over time, thanks to compounding.

So, while high fees are a problem, the fact that investors tend to lose track of the mix of investments (known as asset allocation) in which their old 401(k) accounts are invested. When this happens, dramatic underperformance often follows.

Here are a few reasons that neglect can lead to the poor performance of a Zombie 401(k).

• To begin with, if you leave behind an old 401(k) of $5,000 or less, your former employer is legally permitted to force your Zombie 401(k) account out of the plan and into a Safe Harbor IRA. This process is knows as a Forced Rollover.⁴ These Safe Harbor IRA accounts normally default to a portfolio designed to protect your principal – like a money market mutual fund or a stable value fund – which often have very low returns. As of the date of this blog post, MMMFs typically offer a return of below 1.0% annually.⁵ Currently, stable value funds, composed of high quality bonds, offer slightly higher returns – typically around 2% annually.⁶

• Some 401(k) plans still automatically default to conservative, low-growth investments. So, if you never allocated your 401(k) plan, prior to leaving your employer, chances are your investments may have defaulted to either a money market mutual fund or a stable value fund.

• Even if you had a good asset allocation when you left your former employer, all 401(k) plan investments require attention, eventually. As the investments in your retirement plan ebb and flow, your portfolio asset allocation will shift. Failing to periodically tend to your portfolio could lead to a sub-optimal asset allocation that does not alight with your long-term financial goals. The result could be a 401(k) portfolio with too much – or too little – risk, depending upon your goals and risk tolerance.

To give you an idea of the impact this could have, let’s take a look at a scenario where an investor maintains a well-allocated retirement account inside their new 401(k) or a Rollover IRA. To get an idea of what’s possible, over the past 3 years, managed IRA portfolios have averaged 8.8% annual returns⁷ – after fees! For sake of comparison, I assume fees would total 0.4%; so, average returns before fees would be 9.2%.

 Average annual account returns by asset allocation

When we apply these different returns to a $55,000 account balance, notice what happens:

• Inside a poorly-allocated Zombie 401(k) account, invested in low-growth money market mutual fund with a 1% per year return, the first year returns would be $550.

• However, in a well-allocated 401(k) or Rollover IRA account with a return of 9.2%, the return is $5,060. More than 9 times more than the forgotten poorly-allocated Zombie 401(k).

The takeaway from this example is that the chances of your Zombie 401(k) being well-allocated decline the longer your account remains forgotten and neglected. So, if you’re the owner of a Zombie 401(k), there’s a meaningful chance your account is earning much lower returns than it could be.

Putting it All Together

If we taking into account the impact of fees and returns on a Zombie 401(k) with just the $55,400 average balance of a forgotten retirement plan, the results can be staggering!

• The higher investment returns, 9.2%, of a well-allocated 401(k) or Rollover IRA compared to the 1% growth of a Zombie 401(k) trapped in a money market mutual fund allocation results in an annual difference of $4,510 in returns.

• The lower fees of 0.40% in a managed 401(k) or Rollover IRA versus a Zombie 401(k) paying just the average fees of 0.85% results in difference of $248 per year.

• Following just a single year, the well-allocated 401(k) or Rollover IRA account balance would be $59,840. A stark contrast to the $55,083 in a neglected Zombie 401(k). That’s a difference of $4,758!

As the chart below shows, when you project the Zombie 401(k) effects out over a 30-year career time-horizon, the adverse impact can approach $700,000.

How to avoid or fix a Zombie 401(k)

So, how can you avoid becoming the owner of a Zombie 401(k) or clean up the mess created by your existing Zombie 401(k) accounts? Fortunately, there are several options for dealing with an old 401(k) available for you to choose from:

1. Rollover your old 401(k) into your new employer-sponsored retirement plan, if the plan permits.

2. Rollover your old 401(k) into an Individual Retirement Account (IRA).

3. Convert your old 401(k) to a Roth IRA.

4. Withdraw the cash (“cash-out”) from your old plan.

Over the next few blog posts, we’ll examine each of these options in order to make the best of your 401(k) accounts. Or, if you know you need help with an existing Zombie 401(k), please reach out and schedule a free consultation to discuss a personalized solution.

1. Bureau of Labor Statistics. “Number Of Jobs, Labor Market Experience, And Earnings Growth: Results From A
National Longitudinal Survey.” August 22, 2019. https://www.bls.gov/news.release/pdf/nlsoy.pdf

2. Capitalize. “The True Cost Of Forgotten 401(k) Accounts (2021). May 2021. https://hicapitalize.com/resources/the-true-cost-of-forgotten-401ks/

3. Brightscope/ICI Defined Contribution Plan Profile: A Close Look at 401(k) Plans, 2017; August 2020.
https://www.ici.org/system/files/attachments/pdf/20_ppr_dcplan_profile_401k.pdf

4. Note that the $5,000 balance limit does not include any assets held in the plan as a result of a prior rollover - so higher balance accounts can be impacted by this if they were transferred from another 401(k).

5. There are many money market mutual funds available; consider Fidelity’s popular Government Money Market Fund (SPAXX) and Treasury Money Market Fund (FZFXX), Schwab’s Value Advantage Money Fund (SNAXX), and Wells Fargo’s Cash Investment Money Market Fund (WFAXX), each with 10 year annualized returns below 1%.

6. Vanguard Investments - Stable Value. Accessed May 3, 2021. https://institutional.vanguard.com/web/cfv/fund-list/?filters=stb,&sortBy=assetClass&viewType=quarterEndReturnsNAV

7. Backend Benchmarking, Robo Report & Robo Ranking: Winter 2021 Edition, Published February 10th, 2021. p.38. https://storage.googleapis.com/gcs-wp.theroboreport.com/TBLTKs2bLA6MNKHm/4Q20%20Robo%20Report%20
%26%20Ranking.pdf

The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but is intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax, or personalized financial advice. Please consult a legal, tax, or financial professional for information specific to your individual situation.