Employer-sponsored retirement plans, including 401(k)s, have made it easier than ever for employees to save for retirement.
These types of retirement plans are particularly attractive since many employers offer matching contributions.
While past generations relied on pensions to fund their retirement, current and future generations of American workers will be largely dependent on their own savings.
Although investing in your company’s 401(k) plan is a good way to build your nest egg, frequently changing jobs can make it difficult to establish a solid retirement planning strategy.
The U.S. Department of Labor estimates that, over ages 18 to 44, the average American will hold eleven jobs.
When a job change occurs, many workers cash out their 401(k), which can harmfully impact their finances over the long-term.
A 2009 study published by Hewitt Associates found that almost half of workers cashed out their 401(k) when leaving their job, rather than rolling the money over into an individual retirement account (IRA). Of the 170,000 employees surveyed, a third left their 401(k) money with their employer while just 25% opted to roll the money over into an IRA or similar retirement account. Statistically, the cash-out rate was highest among younger workers, with 60% of twenty-somethings choosing a distribution.
Liquidating your 401(k) may provide you with much needed cash flow if you’re unemployed. However, you should only consider this option as a last resort. Reinvesting your 401(k) into a Rollover IRA allows your nest egg to continue to grow tax-deferred and you also avoid paying costly penalties and taxes.
To see how much money you could be losing out on if you decide to cash out your 401(k), check out T. Rowe Price’s Rollover IRA Distribution Calculator. The amount may shock you.
For example, a 30-year-old who chooses to withdraw the $30,000 balance in her 401(k) will walk away with just $19,500, assuming a 35% decrease for taxes and an early withdrawal penalty. If the same $30,000 was transferred to an IRA, it’d be worth close to $300,000 at the age of 65, assuming a 7% rate of return.
If you’re planning to change jobs or if you’ve lost your job as the result of a layoff, you should think carefully before cashing out your 401(k). The money can be a short-term solution to your financial problems but end up leaving you short-changed when it’s time to retire.