Job Changers: Chill on Your 401(k) Cashing Out, Like Falling In Love, Can Be So Easy, But Both Need Perspective

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Job Changers: Chill on Your 401(k) Cashing Out, Like Falling In Love, Can Be So Easy, But Both Need Perspective

By Jane J. Kim, Dow Jones Newswires

November 12, 2003

Many people are siphoning off their retirement money long before their older -- and wiser -- years.

Nearly half of all workers who changed jobs last year voluntarily cashed out the savings in their 401(k) retirement plans instead of rolling over their assets into their new employers' plans or individual retirement accounts, according to Hewitt Associates, the Lincolnshire, Ill., benefits-consulting firm that conducted the study.

There may be good reasons to take the money and run. People who lose their jobs might see the cash as a way to provide some financial stability until they land a job elsewhere. Others might want to pay down high-interest credit-card debt.

But cashing out of a 401(k) deprives workers of years of compounding, which can turn even small sums into a tidy nest egg. Not only will you be hit with a 10% penalty if you take out the money before age 59½, but you'll also be socked with ordinary income taxes.

Consider this: If a 35-year-old rolls over a $10,000 balance into an IRA, that balance could grow to $68,485 in 25 years, assuming an 8% compounded annual rate of return, Hewitt calculated. By contrast, that amount would grow to only about $33,000 over the same period, after taxes and penalties, if the worker chooses to cash out early and put the money into a taxable account.

The highest incidence of cash distributions occurred among younger employees, with 50% of those age 20-29 taking the money. But the number was high for older people as well. More than one-third of employees 60 and older took their distributions in cash, as did 33% of employees 50 to 59.

What was surprising about the survey, which covered 160,000 employees who took 401(k) distributions last year, was the level of cash-outs for older employees and those with large balances, said Stacy Schaus, a Hewitt consultant. About 87% of workers with $5,000 or less in their accounts took a cash distribution, as did nearly three-quarters of those with balances of $5,000 to $10,000. But the survey also found that 20% of workers with balances between $40,000 and $50,000 and even 6% of those with $100,000 balances and higher opted for a cash distribution.

Employers can force workers with balances smaller than $5,000 to take a cash distribution unless they roll over the amount to an IRA or another employer's plan. If such involuntary distributions are included, then the total number of workers who cashed out (or were cashed out by the company) last year when they retired, left their employer for another job or were laid off rises to 70%, up from 63% in 2001, Hewitt said.
Even if your account is less than $5,000, you won't be involuntarily cashed out by your old employer if you act quickly.

"If your employer gives you paperwork, read the paperwork and if you have less than $5,000, arrange to have the money rolled over into an IRA immediately," said David Wray, president of the Profit Sharing/401(k) Council of America. Companies typically give workers up to 60 days to roll over the money into an IRA or another employer's plan. If the company makes a check payable to you, it has to withhold 20% of the money to pay for taxes.

Under the Economic Growth and Tax Relief Reconciliation Act of 2001, plan sponsors could be required to provide a default option as soon as next year that would automatically roll over qualified plan distributions between $1,000 and $5,000 into an IRA if the employee fails to make a decision.

Until that happens, job switchers still have a number of options.
Most planners recommend rolling over the funds into an IRA. You won't be limited by the investment options in the new employer's plan and you can take distributions from the IRA without penalties under certain circumstances, such as to buy a first home. However, if you choose to roll the money into a plan offered by your new employer, you'll retain the ability to borrow from the account.

Also, consider rolling over just a portion of your balance, suggested Jeff Feldman, a planner in Rochester, N.Y. "It's not an all-or-none decision," he said.

Still, in certain cases, it may help to liquidate your 401(k), said Morris Armstrong, a planner in New Milford, Conn. "Sometimes people say it's the worst thing in the world to cash out, but sometimes it's not," he said. "If it's really going to improve your life -- not your lifestyle -- then I think cashing out is a viable option, as long as you're aware of the costs," he said.