What’s Lost When You Cash Out Early
The Associated Press, DES MOINES, Iowa 1-10-09
Millions of workers every year take a huge chance with their retirement savings: They cash out their
401(k) accounts when they lose their jobs or move to new employers.
When people cash out, a chunk of their money just disappears.
Employers and financial advisers have warned workers about the possibility of retiring poor, something
that's more likely to happen when people cash out their accounts. The rhetoric to keep saving ratcheted
higher over the past year as stock prices fell and the average retirement account balance fell by a third.
But a recent study shows that workers are ignoring the advice - the rate of cashing out has been stable
since 2005.
Business consultant Hewitt Associates looked at the behavior of 170,000 401(k) participants who left
jobs last year. The review shows that 46 percent of those changing or losing their jobs took the cash out
of their accounts. A quarter of the workers either rolled over their money to individual retirement
accounts or other retirement plans and about a third kept the money in their previous employers' 401(k)
plans. The fact that people are cashing out at such high rates does not bode well for future retirees, said
Pamela Hess, Hewitt's director of retirement research.
"Millions of Americans who rely on defined contribution plans will find themselves unable to achieve a
financially secure retirement," she said.
The trend is even worse among workers in their 20s. The problem with those workers taking out their
money is that they miss out on decades of tax deferred growth and the benefit of compound interest on
their investment. An employee who cashes out a $5,000 retirement balance at age 25 would get a check
for just $3,500 after taxes and penalties. Left in an account, that $5,000 might have grown over decades
to $75,000 at retirement, Hewitt said.
In its own research released in January, Employee Benefit Research Institute, a nonprofit group that
studies retirement account trends, looked at cash-out trends. The study showed that more than 16
million people had reported taking some of the cash out of their retirement account when changing
jobs. The average amount taken was $32,000, although most distributions were smaller, with about a
quarter of them $2,500 or less. The EBRI study was based on U.S. Census Bureau survey information
from 2006. Although it's a few years old, it provides insight into how the money was used. While some
people said they simply spent the money, many more reported using it for home purchases, starting a
business or paying down debt.
EBRI says that in 2006, nearly 17 percent of workers who changed jobs and took money out of their
401(k) said they spent it on items like cars or boats or on everyday expenses. More than a third used it
to pay down debt, start a business or buy a home and about 7 percent put the money in a savings
account. Most of the rest put the money in an IRA or another 401(k).
Some critics of the 401(k) might be quick to say this points to a weakness in the current voluntary
retirement savings system - many people simply don't have the discipline to save long-term. The
criticism of the 401(k) as the primary retirement savings method for a majority of workers has grown
with the stock market crash and account losses. Some critics want the voluntary savings plans to be
replaced by a government-run retirement system. Others suggest adjustments to the 401(k) that make
them less susceptible to market losses.
The 401(k) itself shouldn't be blamed, however, said Mike Alfred, the CEO of Brightscope Inc., a Web-
based 401(k) ratings service.
"People are going to say -if they oversimplify things - that it's a failure of the 401(k) plan. But in reality,
it's an issue of the failure of our educational system to incorporate financial literacy for kids at a young
age," Alfred said.
Education is more important now because today's retirees are the last generation of workers to benefit
widely from an employer-provided pension that guarantees an income for life. The rest of us are more
likely to have only our own savings to supplement Social Security when we retire.
401(k) cash-out rates by age
Nearly half of U.S. workres cash out their 401(k) retirement
accounts when they lose their jobs or move to new employres,
according to a new study. (Source: Hewitt Associagtes)
65+
60-65
50-59
40-49
30-39
20-29
0% 10% 20% 30% 40% 50% 60% 70%