Don’t Cash Out Your 401(k) — Here’s Why

You’ve heard this advice before: “Don’t use your 401(k) as a piggy bank.” But according to Fidelity, the largest administrator of 401(k) plans, 35 percent of all Fidelity 401(k) participants cashed out their balances when leaving their jobs in 2013. An even more disturbing statistic is that younger workers (aged 20 to 39) cashed out at a rate of 41 percent!

While interviewing women for my book, “Every Woman Should Know Her Options: Invest Your Way To Financial Empowerment,” it was no surprise that almost every woman in her 50s and 60s who had cashed out her 401(k) or 403(b) when she was younger regretted it. They acknowledged that if they had kept the money to grow tax-deferred in a retirement account — instead of spending it on things that are now long gone — they would not be in fear of running out of money as they face retirement.

Thankfully, there are female role models to show us how life choices can be inspiring, instead of heart-breaking. A woman named Evelyn stopped me after yoga class a few weeks ago and was proud to tell me her personal story. Twenty-five years ago when she left her job and got married, she had $10,000 saved in her 401(k). She and her new husband, John, agreed that instead of cashing out the money, she would roll it into an IRA. 

As a financial advisor, I nearly always recommend rolling a 401(k) into a Rollover IRA. There are infinite, low-fee ways to invest an IRA and an individual can either manage it herself or hire a financial advisor to manage it for her. The other benefit of an IRA is that additional contributions every year up to the federal limit may be made.   

Although Evelyn never added new money to her IRA, she certainly didn't forget about it. She invested in a combination of mutual funds and reallocated the money between funds once every two or three years. As a scientist, she was familiar with the biotech industry, so she initially put a third of her money in an actively-managed biotech mutual fund and the rest in low-fee mutual funds that track the major indices for U.S. and international stocks. Today, Evelyn’s account is worth nearly $140,000. If she had cashed it out when she left her job, after taxes and penalties she would have been left with around $6,000.  

Assuming the same average annual return, if Evelyn had added just $100 per month into that IRA she would now have more than $280,000. It’s amazing what compound interest can do in a tax-deferred account, especially when attention is directed to periodically reviewing, managing, and contributing to such an account.

If you are ever in the situation when you think your 401(k) is so small that it doesn't matter if you take the cash, remember Evelyn. 

Laurie Itkin is a member of the DailyWorth Connect program. Read more about the program here

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