There are several reasons people decide to cash out their 401(k)s. Some people cash it out because they’ve changed jobs and don’t know whether it’s worth the trouble to roll their old 401(k) into a new account, especially if it’s a small amount. Others choose to cash out their 401(k) because they’ve accumulated some high-interest debt and think it may be a smarter financial option to pay it off using their retirement account rather than pay the debt with interest. Still others cash out their 401(k) because they’re in dire enough financial straits that they’re facing bankruptcy and feel that taking money out of their retirement accounts is their only option. The reality is that cashing out your 401(k) is almost never a good choice. Here are some tips to help you decide whether or not it’s a good idea for you as well as some alternate ideas for how to manage your situation.
Changing jobs these days is becoming a more and more common occurrence. While it used to be that employees would work for one company for most of their lives, nowadays, two or three years at one employer seems like a long time. When changing jobs, there’s often the matter of your 401(k) that you’ll have to deal with, making a choice between rolling it into a new retirement account, leaving it where it is, or cashing it out. Because it’s easier to cash it out and also because it’s generally not a terribly large amount (to be expected after only a year or two of employment), more and more people are choosing to take the money and spend it. The problem is, even retirement accounts with small balances really pay off when it comes to compound interest. That thousand dollars you cash out of your 401(k) at age twenty-nine, which is closer to six hundred after taxes and penalties, could be worth fifteen or sixteen thousand by the time you retire, even if you don’t add another penny to it. Visit a 401(k) cash out calculator such as the one at 401k Planning (www.401kplanning.org/calculators-tools/calculate-cost-of-401k-cashout/) to get an idea of how important it is to keep that money invested.
Some people think that turning to their 401(k) to pay off high-interest debt is a smart decision. When you figure just how much you’re paying in interest, this can seem like a good idea, but again you’ll need to take compound interest into account as well as the hefty taxes and penalties you’ll be paying for early withdrawal. Not only will you be wiping out your retirement savings, you’ll also be paying income tax and a ten percent penalty, which could very easily add up to more than you’ll be paying in interest. Figure out how long it’ll take to pay off your debt without touching your 401(k), then compare that to how long it’ll take to replenish your retirement account plus the taxes, penalties, and rate of return you’ve lost. Realistically, even if you’re in seriously dire financial straits, declaring bankruptcy may be a better option. Bad marks on your credit report, even those as serious as bankruptcy, don’t last forever, but how much money you have when you retire is a bit more permanent. It’s also possible that a loan from your 401(k) can solve your problem, although the rules for getting and repaying one are very strict. Speak to a certified financial planner and/or a reputable credit counselor to help you decide what options are best for you.