Personal Finance: 401 (k)onundrum: Cash out when you move on?
Despite record-low saving rates, many American workers are doing a decent job building up their employer-sponsored 401(k) retirement plans. Yes, participation rates in these tax-deferred investments has fallen slightly, from 79 percent in 1997 to 75 percent today. Still, three quarters of all workers who are eligible to participate in these plans do so.
What's more, the average employee who uses a 401(k) now puts away 7 percent of his or her pretax salary each year. That's up from 6.8 percent in 2003 and 6.5 percent in 2001, according to the consulting firm Hewitt Associates. The increased contributions, coupled with the rebound in the equity markets in 2003 and 2004, have helped workers make up for bear market losses.
According to a study by the mutual fund giant Vanguard, the average employee has about $57,100 in 401(k) assets, up from $52,300 in 2003.
Yet there's still something workers have trouble doing—hanging on to their 401(k) money when they change jobs. In today's fluid job market, the average worker can expect to change jobs eight to 10 times before retiring. But an alarmingly high percentage of 401(k) investors choose to cash out their accounts when they leave their jobs—45 percent, to be exact, according to a new study by Hewitt.
For workers who are younger than 59½, that triggers not just an immediate tax bill (remember, you have to pay income taxes on withdrawals) but a 10 percent penalty, too. Combined, the tax and penalty are likely to eat into a significant portion of those withdrawals. "Our findings show that too many workers are not looking at their 401(k) savings as long term in nature," says Hewitt's Lori Lucas, "but are instead using termination of employment as an opportunity to spend this money."
So what should job-switching workers be doing as an alternative? You've got two basic options:
- Leave the money where it is. Many plans allow workers who quit the firm to continue to keep their money invested in the company's 401(k) plan. (You won't, however, be allowed to put new money in.) This is perhaps your easiest option, as you're not making any changes. And it's one reason 32 percent of workers who quit their jobs end up leaving their money where it is. But do this only if you really like the investment options within your 401(k).
- Perhaps a better thing to do when leaving a job is to roll over your 401(k) into a qualified individual retirement account, or IRA. You can do this without triggering taxes or penalties. Plus, you get the added benefit of being able to choose any financial services firm. So if you like Vanguard funds, for instance, but don't have access to Vanguard portfolios in your former employer's 401(k), you can roll your money over into a Vanguard IRA and choose whichever funds you want. You can also put the money in a brokerage account, allowing you to invest in stocks and bonds as well as funds.
advertisement
