Changing Jobs? Leave the Cash in your 401(k)
April 27th, 2007 by digerati
An unfortunately large number of people take money out of their retirement accounts when they change jobs.
A study in 2004 indicated that 45% of departing employees took a cash distribution from their 401(k) accounts, and 27% cash out completely. This is horrible news as cashing out your 401(k) takes a large penalty (10%) plus the lost investment potential over time.
We’ve seen the benefits of compound interest. When you remove a large portion of the money in an account, you don’t earn interest on that amount, nor do you earn interest on the new amount the following year.
Even worse, another study concluded that 66% of those under 30 cashed out the accounts. This is worse since compound interest creates wealth over time. In fact, investing for the first 10 years and letting the interest grow is about the same as investing the next 20 years with the same interest earned.
Consider this scenario: One 22-year-old changes jobs three times in the first 12 years of his career and cashes his 401(k) out each time. He gets religion at age 34, puts away $6,500 and increases his savings $500 each year until age 65.
Another 22 year-old saves $500 her first year in the work force and ups that figure $500 each year for the rest of her career (thus saving the same amount at age 34 and higher as the gentleman up above). She changes jobs, too, but keeps the money socked away.
By the age of 65, assuming an 8% annual return, our steadfast saver has $2.3 million, according to calculations by T. Rowe Price financial planner Stuart Ritter. The man who began at 34 has just $1.6 million.
So what’s the deal? Younger people may need the money for immediate expenses (mortgages, medical), especially if they got fired. But, 66% of those under 30 didn’t get fired, in fact, less than 20% of them did.
My theory is that young people don’t take the time to learn how the accounts work. They either don’t realize that they can leave the money in the account to be managed by their former employer. This means you have to watch and manage multiple accounts over time. To avoid that frustration and confusion, people seem to be cashing out the accounts.
The better option is to roll the accounts over into an IRA account at an independent broker. Fidelity, Sharebuilder, T. Rowe Price, and many others will easily do this service for you easily.
Original Article at CollegeJournal.
Willster Says
Unfortunately I was one of those bright few that decided to withdraw money from their 401k upon leaving jobs. I certainly don’t plan on making that mistake twice.
What a lot of people don’t realize, though, at least of the other people I knew doing this same thing, is that if you use that money towards paying off education costs you can get around the huge 10% early withdrawal tax.
Even so, you have to ask yourself: Am I going to make a habit of cutting into my retirement savings any time my funds are in slim supply? Or would that money be better off left alone, compounding interest ever year?
Apr 27th, 2007 at 5:51 am