Many workers adopt a strategy of withdrawing their 401k money and taking it with them when they change jobs. While such a practice may seem logical, it may also be very detrimental to the overall objective of building retirement savings. Fidelity Investments reported a trend of 35 percent of its plan participants cashing out 401k balances upon leaving their jobs in 2013. Among workers between the ages of 20 and 39, 41 percent cashed out while 51 percent of workers who left jobs that paid an annual salary of less than $30,000 withdrew their balances. The general trend of cashing out for non-retirement spending is reportedly growing.
The Duality of Retirement Savings
Although Fidelity noted strong growth during 2013 in 401k account balances, the story has two sides. At the end of the fourth quarter, the average balance increased 15.5 percent and was at a record high of $89,300. Pre-retirees age 55 and older had an even higher average balance of $165,200. However, 78 percent of the increase was due to stock market gains. On the other hand, young and low income workers are finding saving to be difficult due to economic stress.
Disadvantages of Prematurely Cashing out 401k Funds
Cashing out prior to reaching age 59 1/2 carries a 10 percent penalty in most cases. In addition to being subject to a 10 percent penalty, the withdrawal is also taxed in the same manner as regular income. Furthermore, funds that are withdrawn early do not receive the benefit of compounded growth that would accrue if the money is left untouched until age 67.
The Government Perspective
Policymakers are now weighing the option of imposing stricter rules to discourage the practice of cashing out 401k balances for non-retirement purposes. However, this move may also discourage employees from making contributions to retirement funds altogether. The answer may lie in an increased effort to educate employees on their 401k options when leaving their job. Nevertheless, 25 percent of 401k accounts are terminated after three years with the percentage increasing to 50 percent at the five year mark. It is also possible that employers should rethink the way they structure workplace plans for employees who are less likely to maintain their retirement investment accounts over a long term.
Gary M. Kaplan is a CPA and retirement planning specialist who is qualified to advise tax payers in Florida, Maryland, Washington, D.C., Utah, and New York. Contact our firm to learn more about our services and to receive other valuable retirement tax tips.
