|Don't be dumb -- don't cash out
Cash out a 401(k) before age 59½
and you'll fork over a 10-percent penalty to Uncle Sam and get whacked
for the taxes due on those pretax contributions. So, there's a good
chance you'll lose 35 percent coming off the top of whatever you
have in the plan.
"I think that's what the majority
of employees don't understand," says Kaye Worden, certified
financial counsel with Consumer Credit Counseling Services of Greater
Fort Worth, Texas.
"They get a check with a 10-percent hit and they
assume that's all the hit they'll have to take. They tell me that
the company already took out the penalty and the taxes. I look at
their paperwork and tell them the company only took out 10 percent,
now they'll have to pay the taxes, too. They turn to paste."
Eric Hutchinson is a certified financial planner and
founder of Hutchinson/Ifrah Financial Services in Little Rock, Ark.
In part, he blames the idea of cashing out on the move away from
defined benefit plans to defined contribution plans where much of
the responsibility shifts to the employee.
"There's a lack of sophistication to understand
the issues involved. We hear about it in the companies where we handle the retirement
plans. We might have contact with the employee and counsel them about the taxes
and the penalties, but their eyes glaze over with their immediate wish list --
a boat, a car. What they don't understand is that they're shortchanging their
federal rules regarding low-balance 401(k)s should
help alleviate the problem of employers cashing out balances of
less than $5,000 when a former employee neglects to provide rollover
instructions. The new law says employers can only do that when an
account has a balance of less than $1,000. But all employees need
to grasp the damage that's done to retirement plans when money is
Even twentysomethings should have a hands-off policy
when changing jobs. A couple thousand dollars may not seem like
much, but if it's left in the account for 40 years and grows at
just 6 percent a year, it'll turn into more than $20,000. An account
with $5,000 would grow to more than $51,000. That's a lot of money
to miss out on when you retire. For older employees, the consequences
of cashing a 401(k) are worse, because there's less
time to rebuild that nest egg.
Too many Americans are setting themselves up for a
fall when they retire. The most recent government statistics say
we're saving at a rate of negative 0.6 percent. That means we're
spending more than we're making. We're not saving, we're dipping
into our savings. Combine that with people cashing out retirement
plans, or not contributing to begin with, and the scenario is quite