Cashing Out 401(k)s Diminishes Retirement Security

Young savers could forfeit years of potential investment gains

By Stephen Miller, CEBS Feb 21, 2014

More than one one-third of 401(k) participants cashed out their account balance when leaving their job in 2013, with the average cash-out value at nearly $16,000, according to data from Fidelity Investments. The trend is highest for younger participants ages 20 to 39.

People with a 401(k) who change jobs have a critical decision to make: take the quick cash or keep the balance invested in a tax-advantaged account. “Everyone’s personal financial situation is different and there are times when a person must have access to cash,” said James MacDonald, president of Workplace Investing at Fidelity. However, “young savers with years of potential investment gains,” in particular, should strive to keep their 401(k) savings working for them in a tax-advantaged retirement account when changing jobs.

The consequences of cashing out a 401(k) may be significant. For example:

  • A hypothetical 30-year-old who cashes out $16,000 could lose $471 per month in retirement income cash flow by not leaving it invested in a retirement account (assuming he or she retires at age 67 and lives through to be 93).
  • Those cashing out must pay applicable federal and state taxes plus a 10 percent penalty for early withdrawal. In the hypothetical example, a $16,000 cash-out would result in about $3,200 in taxes and another $1,600 in penalties, leaving about $11,200.

“Cashing out is tempting, especially in times of transition like changing jobs,” MacDonald said. That’s why employers should educate employees on both the cost of cashing out as well as the tremendous opportunity for growth by remaining invested.

Departing employees should consider alternatives to cashing out their 401(k), such as keeping the balance in their former employer’s plan, rolling in the balance to a new employer’s plan if eligible, or rolling over the balance into an individual retirement account (IRA). In doing so, they preserve their opportunity to build a retirement nest egg sufficient for a secure retirement.

Average Account Balances Up

In a positive development, the average 401(k) balance continued its growth trend in 2013, ending the fourth quarter at a new record high of $89,300, up 15.5 percent from one year earlier, and nearly double what is traditionally considered the market low of March 2009 when it was $46,200, according to Fidelity’s data.

For pre-retirees age 55 and older, the average balance was $165,200.

While 78 percent of the year-over-year increase was due to upward stock market momentum, a full 22 percent of the growth came from employee and employer contributions, such as company matches, demonstrating the importance of continued participation and contributions.

IRAs Included, Too

To provide a more complete picture of retirement savings, Fidelity also studied the combined balances for investors who hold both a 401(k) and an IRA, as many people roll over 401(k) funds into an IRA when changing jobs. For these investors, the combined 401(k) + IRA average balance was $261,400—up 16 percent from the end of the fourth quarter of 2012 when it was $225,600.

Stephen Miller, CEBS, is an online editor/manager for SHRM.​​

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