Kya Gream, 25, recently started a new job as a medical office assistant in Champaign, Ill. Her old employer sent her a thick packet about her options for rolling over her retirement plan, but she has not scrutinized the information, since it looks a bit daunting.
Still, she has worked hard to amass a five-figure nest egg and aims to avoid emulating a friend who drained her own retirement account to pay for her wedding: “I’ve read that it’s terrible to cash out your 401(k),” she said.
Yet that’s just what many 20-somethings end up doing. More than half of workers in their 20s who have 401(k) plans cash out their holdings when they change jobs, partly because their balances are relatively low, according to a report from the benefits consultant Aon Hewitt.
Only about a third of people who change jobs in their 50s do the same, according to the report, which examined 1.8 million participants in 110 large retirement plans.
Jacob Kuebler, a friend of Gream’s and a financial planner with Bluestem Financial Advisors in Champaign, says when young adults are switching jobs, it is tempting to withdraw the cash for expenses. In addition, he said, it is often difficult for them to envision retirement.
Carrie Schwab-Pomerantz, president of the Charles Schwab Foundation, a nonprofit organization set up by Charles Schwab & Co., said cashing out when switching jobs is a mistake. The withdrawn funds will be counted as income and subject to tax. Also consider that you’ll pay a penalty for withdrawing the money before retirement age.
Charles Schwab gives an example: Say you have $10,000 in your retirement plan, and you cash it out. You’ll pay a 10 percent federal penalty, or $1,000, for taking an early retirement withdrawal.
And because the money was put into the account on a pretax basis, the total amount is subject to income taxes — about $2,500, based on a 25 percent marginal tax rate. So you’ll net just $6,500 — and possibly less, when any state taxes and penalties are included. But the real impact comes from the longer-term investment you will lose out on.
According to Schwab’s projection, which assumes an annual return of 6 percent, the funds could be worth more than $100,000 after 40 years. That’s why it generally pays to reinvest the funds in a retirement account. Your options may include leaving the money where it is, or reinvesting — “rolling over” — the funds into your new employer’s 401(k) or into an individual retirement account.
Questions to consider when you’re changing jobs:
Can’t I leave my money in the retirement account at my old job?
In general, you can let the money stay put as long as you have more than $5,000 in the account; employers may not allow you to do so if the balance is lower. But you cannot contribute new funds to the account after you leave.
What do I have to do to complete a rollover?
The human resources department at your new company can help walk you through the steps to move the money into its retirement plan. Or, if your new employer does not offer a retirement plan, you can roll the money into an individual retirement account.
My old employer mailed me a check for the money in my retirement account. What should I do with it?
Companies may close retirement accounts with balances below $5,000, Kuebler said. If you don’t elect to roll the money directly into a new retirement account, they may send you the balance, less 20 percent to pay federal taxes.
You still have 60 days to put the money into a new retirement account, before it is subject to taxes and penalties. But, Kuebler warns, you’ll have to deposit the full balance, and the amount withheld cannot be recovered until you file your tax return.