According to a new study by Hewitt Associates, an alarmingly high percent of workers — 46 percent — took a cash distribution from their 401(k) plan when they left their job in 2008. The remainder of employees either rolled over their money to a qualified Individual Retirement Account (IRA) or other retirement plan (25 percent) or kept their savings in their prior employer's 401(k) plan (29 percent).
Young vs. older workers
Hewitt's study showed that younger workers were more likely to cash out their 401(k) account than those who are older and more tenured. Six in ten (60 percent) employees in their 20s took a cash distribution, compared to just one-third (34 percent) of those in their 50s.
"The high cash-out rate among young and middle-aged workers is troublesome because these employees are missing out on the opportunity for decades-worth of tax-deferred growth on their investments," Pamela Hess, Hewitt's director of retirement research, said in a release. "Over the course of 20 or 30 years, modest amounts of savings can turn into surprisingly large sums of money."
A guaranteed looser
What's more, workers who take a cash distribution will likely pay taxes and a penalty on the distribution. "Cashing out of a 401(k) is a guaranteed way to increase taxes and pay more to Uncle Sam," said Bill Winterberg, technology editor at advisors4advisors.com. When leaving a job, even if your balance is small, Winterberg suggests that you consider the decision in this light. "Reframing in terms of more taxes paid rather than a penalty should deter some from cashing out," he said.
A Registered Investment Adviser (RIA) like Oaktree Capital can help address the impact of a cash distribution on your financial plan and advise you on the best way to roll over your investment.
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This article was produced by the Financial Planning Association, the membership organization for the financial planning community, and was edited by FPA member Robert S. Jackson, PhD. and Patrick Murfin of Oaktree Capital Corporation.
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