A survey recently about what people are doing with their 401K balances when they leave their job revealed disturbing results. Millions of workers make the choice to cash out on their retirement plans when leaving a company, sacrificing the potential for tax-deferred growth, paying IRS penalties, and essentially making the decision to start over on saving for retirement. It’s easy to blame the economy and the tough time people are having making ends meet on this trend, but the survey results have been the same since 2005.
The trends show that young people are the most likely to cash out, probably because balances are smaller and they feel like they have more time to start over and rebuild. However, it’s younger workers who are giving up the most when they cash out thanks to the power of compounding returns. Of workers in their 20’s leaving jobs, 60% currently are cashing out their 401K balances.
Whenever leaving a job with a 401K, you have a choice of what to do with the funds that are fully vested and in your name. The choice you make for your retirement dollars will have a big impact on the lifestyle you’re able to enjoy during your retirement. Here are the choices available, in most cases, when leaving a job with a 401K.
– Cash Out: If you’re under age 59 and a half, the IRS is going to charge you a 10% penalty for cashing out early from your 401K unless you qualify for an exception. In addition to the penalty, taxes will be due on any amount withdrawn from a 401K. Between these two financial consequences, a worker is giving up somewhere between 15 and 40% of their retirement savings to get their hands on the cash today. This is an option that should only be chosen during a time of extreme financial need.
– Rollover to an IRA: About a quarter of workers leaving their jobs roll the money out of their employer-sponsored retirement plan and into another qualified plan. One advantage of a rollover into an IRA is that the rollover is not a taxable event and the money continues to grow on a tax deferred basis. Another is that in an IRA, the investment options are much more diverse than in a 401K, where owners are usually limited to just a few mutual fund choices.
– Rollover to a Qualified Plan: In addition to IRA accounts, some employees roll their 401K balances into the retirement plan with their new employers. Not all 401K plans accept rollovers from other qualified plans so you’ll need to ask your HR department about portability in their 401K plan. The advantage of this type of a rollover is that it keeps your retirement dollars consolidated and avoids overlap concerns. The disadvantage is that the investment options are more limited than in an IRA account.
– Leave It With Old Employer: The final option is that the retirement money that has been saved can be kept in the 401K plan with the old employer. This is easy to do and about a third of all workers leave their 401K behind when they leave their employer. The advantage is that it requires you to do nothing, but many people like to cut all ties with former employers and this option does leave some strings attached. In addition, 401K assets can be frozen occasionally if the company sponsoring the plan goes into bankruptcy.
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