45 percent of people who switch jobs before age 59½ cash out on their retirement plans. Perhaps sometimes this is necessary, especially if the reason why you cashed out was due to an unexpected job loss where no other sources of income were immediately available to you. Still many others do it without fully understanding the potential harm they are doing to their long-term retirement prospects. Right off the top, you’re giving up 20-40 percent of your money if you cash out on your plan to taxes and penalties. Moreover, you’re missing out on future compounding of that wealth.
To put it into numerical context, here’s an example. The following table shows how much a person age 30 who earns $40,000 could save in a 401k plan using the AARP 401k calculator. The example assumes the person’s contributions started at $0 at age 30 and assumes an annual contribution of 10 percent of his salary, an annual salary increase of 1 percent, an annual rate of return of 7 percent, and an employer match of 50 percent of the employee’s contributions up to 6 percent of the employee’s annual salary.
If this person withdrew his savings balance of $88,946 at age 40, then that money would never have a chance to keep earning compound interest up to his retirement at age 65, resulting in a loss of $743,700! Even cashing out just a few years before the example retirement age of 65 could result in a $200,000 loss in earning potential.
So unless the money is absolutely needed, think twice about just cashing out that 401(k) balance when you switch jobs. Know your options, which includes rolling the proceeds into a new employer’s 401(k) plan or your own IRA account so it continues to grow tax-deferred and compound interest until you need it in retirement.