46% of Employees Cash Out their 401k when Changing Jobs or upon Losing Jobs

(November 11th, 2009)

Des Moines, Iowa - According to a study done by Hewitt Associates on 170,000 employees who left or changed jobs last year, 46% of them cashed out their 401(k) plans instead of rolling over to an IRA (do an IRA rollover) or rollover to their new employer's plan. About 25% of the workers rolled over to an IRA and 29% of them left their 401ks with their old employers. Pamela Hess, Director of Retirement Research @ Hewitt Associates thinks the fact that almost half of the workers are cashing out their 401(k)s is not good for future retirement planning. Reasons why workers could be cashing out as a result of job loss is due to a lack of income, 401k financial hardships under which withdrawals can be made. Pamela quotes, ""Millions of Americans who rely on defined contribution plans will find themselves unable to achieve a financially secure retirement." This chart shows the age groups of US workers who cash out their 401k plans. We see that 60% of workers in the 20 - 29 years age group cash out their 401ks when changing or losing jobs while this number drops to 47% for people in the 30 - 39 years age group, finally dropping to 31% for people in the 65+ years age group. This makes sense because people in the 60-65 years age group theoretically will have more money than young workers in the 20 - 29 years age group.

Due to the recent economic downturn and the fall of the stock markets, many people already have lost a huge chunk of their 401k accounts. Added to this, making premature 401k withdrawals (any withdrawals made before 59 and 1/2 years of age) will result in a 10% early withdrawal penalty by the IRS. This trend is even worse for people in their 20s, they are missing out on decades of tax-deferred growth of their funds & the power of compounding interest According to experts in the 401k industry, a young worker who cashes out a $5,000 401k account will only take home $3,500 after penalties & taxes. If left in a retirement account, this sum of money would have grown to over $75,000 at the age of 65 (based on a 40 year compounding interest schedule) according to Hewitt Associates.

Case Study

Hewitt Associates provides us with a case study of Jeremy Caverly, a 29 year old man of Silver Springs, Maryland who learned the hard way that cashing out a 401k was not a good option. After receiving a job offer from a new employer while he was in his early 20s, Jeremy cashed out his 401k and gave a 4 week notice to his old employer. Just 2 weeks later, the new job offer was withdrawn by his new employer and Jeremy was left jobless. Upon this event, Jeremy saw an opportunity to tap in to his 401k and cash out his 401k to get by until he found a new job. He managed to get $10,000 from his 401k after penalties & taxes. He used some of the money to pay for a travel trip with his friends and the rest of the money to pay for his expenses. Jeremy recalls being horrified by the 30% upfront in taxes and 10% in penalty that he paid that shaved off a huge chunk of his 401k balance. Furthermore, he received a huge bill from the IRS for that year considering the $10,000 cash withdrawal was treated as earned income for that tax year.

Jeremy quotes, "It made me sick when I saw the amount of the check compared to how much was actually in the account, how much was taken out in fees and penalties. Then I was floored when I got that bill for thousands of dollars in extra taxes." He thinks many young people tap in to their retirement savings if they have no other savings or alternatives such as friends or family to borrow money from. He quotes, “They see it as money I put away and I'll use it as a rainy day fund.” Jack VanDerhie, Director of Research at Employee Benefit Research Institute (EBRI) quotes, “Psychologically, if you're young and you only have a few hundred or a few thousand dollars, you think, I'll save for retirement at my next job.”

According to further research released by the Employee Benefits Research Institute in January 2009, it was found that upwards of 16 million people were taking cash out of their retirement accounts when changing jobs. The average 401k withdrawal was $32,000 however a quarter of all 401k distributions were less than $2,500 which suggests a short term emergency need for employees due to job loss, etc. EBRI further suggests that in a study conducted in 2006, almost 17% of employees who changed jobs took money out of their 401k plans and spent it on items like cars, boats or extra-ordinary expenses. However more than 30% of the people used the money to pay off debt, buy a house or start a small business.

Critics are saying 401k plans should not be used as retirement savings vehicle; it should be changed to a government run retirement system where benefits are guaranteed and the downturns of the stock market avoided, as well as the major mutual fund & hedge fund collapses. Other critics suggest people find it very hard to set a mindset for long term savings, instead they like to spend all their money in the short term, especially young people. These critics therefore suggest increasing financial literacy in America especially amount the youths who are most risk averse.

Related Links

Employee Benefit Research Institute - http://www.ebri.org

Founded in 1978, the mission of the Employee Benefit Research Institute (EBRI) is to contribute to, to encourage, and to enhance the development of sound employee benefit programs and sound public policy through objective research and education.