If you find yourself in need of quick cash, whether for an emergency, a new car or to pay down debt, there are very few things more tempting than the money sitting right there in your retirement account. That money becomes even more tempting if you lose your job or quit working, but the fact is that withdrawing those savings and using that money can gravely damage your retirement income.
In 2013 nearly 35% of people who left their job cashed out their retirement savings when they did, rather than keeping it in a retirement account that was tax qualified. While this might have been a financial necessity for some (and it’s not surprising that, among people who make lower incomes, it’s done more often) it can be a very costly decision.
People making between $20,000 and $30,000 a year as well as young savers are the most prone to cashing out their retirement funds early. In fact, of people 50 to 59 only 26% cashed out their retirement funds when they lost their job or quit as opposed to 44% of those people between the ages of 20 and 29.
Here’s an example of why this can be a truly ruinous financial decision. If a person who is 30 years old cashes out a 401(k) worth $16,000 they would owe about $3200 in taxes as well as be forced to pay nearly $1600 in early withdrawal penalties, meaning that the leftover money would equal $11,200. Even worse, assuming a real return a 4.7%, a person’s retirement income would drop by approximately $470 a month if they retire at the age of 67 and live to the age of 93.
One study found that people who cash out their retirement plans early will see their retirement income dropped by 11% all the way up to 67%, depending on when they cashed out. According to Beth McHugh, vice president of market insights at Fidelity Investments, “people probably shouldn’t look at touching their 401(k) from day one. Some people go into that quickly. They may not understand all of the implications.”
McHugh Added that “when you are changing and advancing your career, you want to make sure you’re advancing your retirement as well, and that you’re not taking a step back every time you move to a new employer by cashing out.”
One good bit of news is that average balances have almost doubled.
A Fidelity Investments study found that in 2013 the average 401(k) balance was $89,300 or almost double the average from the same time in 2009, a 15.5% increase. This is most likely due to the stock markets rising 2013 which contributed a 78% gain to the average balance. The other 22% was due to employee and employer contributions.
Still, as you can clearly see, cashing out your retirement savings when you leave your job is possibly one of the worst financial decisions that you can make. Before you do, make sure to talk to your financial advisor and find out if there are any other alternatives that you can use that will, in all likelihood, save you a lot of money now and make you a lot more retirement income in the future.