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IRAs Winning Out Over 401(k)s


Maybe it's that rugged American individualism. Or maybe it's fallout from watching pensions peter out, Social Security shrivel and the prospects for their golden years begin to look rather glum. More and more workers are choosing individual retirement accounts (IRAs) as their retirement planning tool of choice over 401(k)s and other employer-sponsored defined contribution plans, according to the Employee Benefit Research Institute.

For fund companies hoping to win that business, that means both big opportunities and some marketing challenges.

The Washington-based group recently reported that not only are the $2.55 billion in assets in defined contribution plans outpacing the $1.87 billion in traditional defined benefit pension plans, but IRAs are outpacing them both, with $3.48 billion in hand.

"What you're seeing now is the tip of the iceberg," said Jack VanDerhei, a project director at EBRI.

Until 1997, defined benefit plans represented the bulk of Americans' nest eggs. DC plans chugged past traditional pensions for the first time that year. By 1998, IRAs inched above DC plans, with $2.15 billion worth of assets, compared to $2.11 billion for defined contributions. Since then, the gap has only widened.

"IRA growth will continue to outperform the other two and by a very wide margin," VanDerhei said. That's because the majority of the funds coming into IRAs roll in from DC funds, such as employer 401(k)s, according to VanDerhei.

"This is a big issue for many individuals," said Ann Mahrdt, a director at the Spectrum Group of Chicago. "They want control of their assets, and with an IRA rollover, they feel as though they have that control," she said.

The age of paternalistic companies that looked after their employees in exchange for a lifetime of loyalty are over. Today's average American worker holds nine jobs between the ages of 18 and 34, according to the United States Bureau of Labor Statistics. Men over 35 stay with their company for fewer years today than they did 20 years ago, the statistics show.

Although the law allows those 401(k) plan participants to keep their savings with the administrator after they leave, there is little incentive to do that either for the employee, who is no longer receiving any employer match, or for the employer, who then maintains fiduciary responsibility and all the costs that go with it.

Furthermore, the more frequently a worker hops jobs, the potentially more numerous, and most likely smaller, disparate employer-sponsored retirement accounts he or she might have. Consolidating them into one rollover account simply makes sense, VanDerhei said.

For fund companies, that means more money streaming out of accounts controlled by the manager chosen by a person's employer and into the open market.

"There's a lot of competition for those dollars," Mahrdt said. And there are a lot of dollars at stake. In 2004 alone, American employees pulled $353.4 billion out of 401(k) and other DC plans, according to Spectrum. The rollover IRA market captured $179.8 billion, or about half.

In order to capture those rollovers, fund companies and their network of brokers must first educate investors. "People generally have a few pieces of information, but generally do not know all of the options available," said W. Ryan Poindexter, a certified financial planner with M.D. Financial Services in Houston. "People leave an employer, and it's months or sometimes years later that they address it," he said.

"We see inertia as a major problem," said Jack C. Harmon, a certified financial planner and principal of Harmon Financial Advisors in Atlanta. According to Spectrum, in 2004, nearly 16% of those who were eligible to roll over their 401(k) plans, or approximately 902,000 individuals, chose instead to leave it with their old employers' plans.

"We find that alarming," said Harmon. By leaving their money in a 401(k), investors forfeit the wider array of funds available to them through an IRA. In addition, 401(k) plans are less estate-friendly, he noted. In the event of death, a 401(k) plan pays out at once, socking the beneficiary with hefty income taxes. IRAs, on the other hand, can be rolled into the beneficiary's own tax-deferred plans, thereby having the tax penalties, and the payout, stretched over the span of several years.

"People realize or have a sense of what they could be doing, but are not necessarily at the point that they automatically need to do it [or have] a compelling reason," said John Davis, vice president of retirement services at OppenheimerFunds in New York.

The challenge for fund companies becomes making sure investors know about IRA options, and then, of course, making sure those investors choose their funds.

"We are always communicating with investors," said Jennifer Engle, a spokeswoman for Fidelity Investments of Boston. For direct sale shops like Fidelity, that means direct mailings, television spots and Internet banner ads.