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The Devastating Effect of Cashing Out Your 401(k)
Posted By Ron On October 17, 2011 @ 1:11 AM In Investing,Retirement | Comments Disabled
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.
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.
That difference is due to the incredible and powerful effect of compounded interest. It may be an urban legend, but when asked to name the greatest invention in human history, Albert Einstein is said to have simply replied “compound interest.”
You don’t have to take the money and run! It’s probably better for you in the long run that you DON’T!
Some companies will allow you to leave your money in their 401(k)  plan despite no longer working there. Usually there are balance minimums ($1,000 to $5,000). If you like your investment options under your former employer’s plan and the fee structure isn’t out of line, this is an okay choice.
The kicker is: do you like the investment options offered under this new plan as opposed to the old plan? If the answer is YES, then your life probably got a whole lot easier from an administrative point of view, plus you’ll be able to continue making contributions to your retirement plan.
I’m partial to Scottrade  because that’s where my personal IRA is located, but you can also roll your money into an E*Trade , optionsXpress , or Zecco IRA  as well. If you plan on actively trading stocks, be sure to examine your trading costs. Both Zecco  and optionsXpress  have very low trading costs at only $4.95. Each of these brokerage houses has rollover experts to help you handle the details and rolling over all your other retirement accounts into one at one of these brokerages will help you maintain your proper asset allocation . Whether a Roth or a Traditional IRA is right will depend on your income level and your personal retirement plans.
You have two options for getting the ball rolling:
Guess which one is easier?
DO NOT have the check made out to you personally. If this happens, the money will be treated for tax purposes as income, just as if you cashed out. Instead have the money wired to the brokerage house  you’ve chosen. It’s really easy if you choose Scottrade  since they have hundreds of local offices all over the country.
If you DO take possession of a check (made out to the brokerage house), you’ll have only 60 days to deposit it into your IRA. Miss that deadline and you’ll incur the 10 percent early withdrawal penalty. Ouch!
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