According to a recent analysis by Fidelity, one in every three retirement savings plan participants has cashed out of a previous employer’s savings plan, often when changing jobs.*
It sounds like an easy way to solve a short-term cash crunch, doesn’t it? Liquidating an old 403(b), 457(b) or 401(k) plan may not seem like a big deal, especially if you have a small balance. But over a long period of time, the consequences of cashing out can be devastating to the average investor.
Here’s why: Once you withdraw those savings, they’re gone—and they can’t be replaced. The power of a tax-deferred account, such as a 403(b), is that it allows pre-tax contributions to compound without taxes eroding that growth. Over time, earnings can generate earnings of their own. And that can help you accumulate more money than you would in an ordinary taxable account.
Whether you need $3,000 or $30,000, when you dip into your retirement savings plan account, the impact can have long-term effects on your savings. If you’re a younger investor, you miss out on a long-term growth opportunity, which can set your retirement savings back considerably. If you’re older, cashing out may take away a key part of your retirement income picture.
There is an immediate cost to cashing out, too. For one thing, it can generate a large tax bill. Typically, your plan automatically withholds 20% of your balance and sends it directly to the IRS to cover the taxes you may need to pay on that withdrawal. And if you are under age 59½, you may also pay a 10% early withdrawal penalty.
That means you will give the IRS nearly a third of the money you’ve been saving for years.
Fortunately, there are alternatives that can help keep your savings intact—and, potentially, growing. If you need money or are considering what to do with an old 403(b), 457(b), or 401(k), here are some options:
Neither a loan nor a withdrawal is an optimum solution, however. If you are able to take a hardship or emergency withdrawal, you will owe ordinary income taxes and possibly an additional 10% penalty on the amount you withdraw. If you take a plan loan, you’ll avoid the taxes and penalties, and you’ll have to pay yourself back, with interest. However, since your investments will be liquidated to make the loan, if the market shoots up, you’ll miss those gains.
Before you make a decision, you may want to take these steps:
* Fidelity analysis of 800,000 terminating participants in 21,200 plans; age based on 12/31/12 data.