Cashing out: the big 401(k) mistake

Published: February 13, 2014
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Workers’ 401(k) balances have never been bigger, thanks to continued contributions and a surging stock market. But many savers continue to make a mistake that costs them thousands of dollars, if not more.

When workers leave their jobs, they can leave their 401(k) accounts alone, rolling them over into another tax-deferred retirement account, or cash them out and pocket the money. Last year, 35 percent of all participants who left their jobs cashed out their accounts, according to the nation’s largest 401(k) provider, Fidelity Investments. That’s up slightly from 32 percent in 2009.

The move provides some quick cash, but it’s also likely the accountholder will have to pay penalties: Nearly everyone younger than 591/2 must pay 10 percent of their account balance as a penalty. Add the income taxes that come due, and the price tag quickly escalates.

The average balance of a 401(k) account that was cashed out last year was close to $16,000, Fidelity says. Of that, the typical person pocketed just $11,200 assuming 20 percent was withheld for taxes and the 10 percent penalty was assessed. But that’s not the worst of it, says Jeanne Thompson, vice president at Fidelity Investments. It’s the lost opportunity for the saver, who no longer gets the compounded growth the savings would have had in a retirement account.

Cash-outs are most prevalent among younger workers, the ones who would most benefit from keeping the money in a tax-deferred retirement account. They have the most years of possible compounded growth ahead of them before retirement. Among workers from 20 to 39 years of age who left their jobs last year, 41 percent cashed out their 401(k) balances.



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