Far too many people, 45 percent in 2008, choose to cash out their 401(k) account when they leave a job. Given the economic conditions, I’d be willing to bet that number has risen. What generally happens next involves shopping sprees, vacations, and drinks on the house … and a huge amount of taxes.
Changing jobs is a fact of life – you will probably change jobs at least a few times over your career. As a matter of fact, the average number of job changes for today’s college graduates is twelve! Almost half of all people who change jobs and have a 401(k) will take their retirement money in the form of a check made out to them personally and will then spend the money earmarked for their retirement on consumable items … after paying 20% to 30% in taxes and another 10% penalty if they’re under 59 1/2. All in all, they lose approximately 40 to 50 percent of their balance.
The numbers
Assume Ashley is a 35 year old in the 28% tax bracket and plans to retire at age 65. Her 401(k) balance is $50,000.
- If she cashes out, she will net only $31,000.
- If she rolls her money into a Scottrade IRA, and achieves an 8% return, at retirement she will have $546,786 (compounded monthly).
- The difference – with no other contributions – is an astounding $515,786.
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