This retirement misstep could cost you more than $100,000 in savings. Here's what to know.

Millions of workers are making a critical mistake with their IRA rollover accounts — one that could cost them $130,000 or more in foregone investment gains, according to new Vanguard research. 

The issue stems from a quirk in the retirement system, with individual retirement accounts legally required to steer all direct contributions and most rollovers into cash, making it the "de facto default" for IRAs, Vanguard noted. That's not the case for 401(k)s, which have default options that direct workers into investments like target-date funds and the like. 

The problem, Vanguard says, is that many workers appear unaware that their IRA savings are funneled into cash, a historically poor performer when compared with equities and other investments. Keeping one's retirement assets in cash not only means that workers are losing out on the potential long-term gains, but are also eroding the value of their savings due to inflation.

Among IRA rollovers from 2015 that were tracked by Vanguard, 28% were still invested in cash seven years later — meaning that those accounts lost seven years of potential investment growth. When the financial services firm surveyed workers about their IRAs, two-thirds were unable to accurately say what they were invested in. Only one-third said they were intentionally parking their money in cash.

That suggests many workers are likely unaware their IRA savings are sitting in cash, said Andy Reed, head of investor behavior research at Vanguard and a co-author of the study. 

"If you think you are invested, think again," Reed told CBS MoneyWatch. "I know a lot of people with IRAs who think they are invested, and when they check they are unpleasantly surprised."

The difference in investment returns between cash and equities is stark. Large U.S. stocks returned an average of 10.5% a year from 1970 through 2023. Cash and money market funds typically earn very little interest, although some accounts are currently paying rates of about 5%, a result of the Federal Reserve's flurry of interest rate hikes. 

"We've had extended periods where cash is paying basically next to nothing, so you have no chance of growth," Reed noted.

Missing out on $130,000

Over time, sticking with cash can create a huge drag on your retirement savings, Vanguard said. Their research shows that investors who are under 55 years old and who put their IRA funds into a target-date fund, versus staying in cash, will enjoy an increase of at least $130,000 in retirement assets by age 65. 

That's significant given that the average retirement account holds about $88,000 in savings.

An additional $130,000 means workers "could retire earlier," Reed said. "Secondly, they would have less likelihood of running out of money in retirement. And the third thing is you can enjoy a higher standard of living in retirement," such as taking one more vacation each year or not being forced to downsize your home. 

Altogether, Americans are giving up $172 billion in investment gains each year due to their IRA's cash investments, Vanguard calculated. And that's likely to be a conservative estimate, partly because the figure only includes rollovers and excludes direct contributions, which are also put into cash by default, Reed said.

What's more, the people who are most likely to keep their IRA savings in cash are typically those who need the most help building retirement savings, Vanguard found. Younger investors, as well as low-income workers and women, are most likely to fall into the cash trap, which could be due to lack of awareness, Reed said. 

"It's really unfortunate because these are the most vulnerable populations," he noted. 

How to avoid the cash trap

First, Reed advises to check your IRA accounts. From there, you can pick new investment options, switching from cash to equities, mutual funds or other vehicles.

"Taking a look at how your IRA is invested is the most important step," Reed said. 

But Vanguard is also urging new legislation that could address the problem's root by requiring IRA contributions and rollovers to be placed into a so-called qualified default investment alternative, or QDIA. This became the law for 401(k)s through the Pension Protection Act of 2006, which allowed these retirement plans to set default investments, such as target-date funds, for people who neglect to make investment choices.

Such a change would require legislation, which would not be an easy lift, Reed added. 

In the meantime, investment companies can nudge IRA investors to look at their plans, which would require workers to take an active role in their investments, he noted.

Either changing the default savings options or getting more people to peek at their IRAs could pay off in the long-term by giving workers a better chance of building a nest egg. 

"It's not a silver bullet for the retirement crisis, but the crisis is significant, and where we see the most acute gaps for preparedness is at the lower end of the socio-economic spectrum, where this solution would disproportionately help," Reed said.