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Anya Kamenetz Generation Debt

Anya Kamenetz, Generation Debt

Caution: Don't Cash Out That 401(k)

by Anya Kamenetz

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Posted on Monday, July 28, 2008, 12:00AM

Ok, it's cautionary tale time.

A good friend of mine graduated from college with a degree in computer science, and landed a great job at a telecom company in the late '90s. The job offered a good salary, lots of fun overseas travel, and a 401(k).

Fast forward about four years and my friend has left the job, enrolled in graduate school, and started a business -- without bothering to roll over his old 401(k) or even pay attention to the statements that came in the mail. Too bad the account was mostly invested in company stock, which had lost 90 percent of its value by the time he finally began to pay attention.

This is an extreme example, but the problem is all too common: Keeping track of your retirement accounts and keeping your overall portfolio balanced can be confusing as you change jobs, homes, and life paths. As young workers, we're in charge of our own retirement, and we're going to switch jobs an average of at least every four years, for a total of more than 10 jobs in a career. When making these transitions, the key is to never cash out your savings, and don't let them languish in old accounts either (if you do decide to keep your cash parked, make sure it's because you're getting a better deal -- and remember to keep track of it).

Crucial Savings Years

These are the most crucial saving years of our lives, when the time value of money is greatest, and you can avoid major, damaging losses by making sure your retirement savings stay current and stay with you. Here's what you need to know to keep things simple and up to date.

Most readers of this site should be familiar with the terms, but just in case: a 401(k) is a tax-sheltered retirement investment account provided by an employer, which may have an employer-provided match on contributions. An IRA or Individual Retirement Account is similar, only without any employer involved -- you can, and should, open one even before you take your first job, and you can have both a 401(k) and an IRA at the same time. The money you put in either type of account can be invested in any combination of stocks, bonds, mutual funds, etc.

Recently, Fidelity Investments, the nation's largest IRA and 401(k) provider, surveyed 20- to 40-year-olds and found that a disappointing 40 percent of them had cashed out their 401(k) when leaving a job. John Ragnoni, the company's Senior VP of retirement products, calls this decision a "retirement killer," which he explains with a simple example.

Let's say you somehow managed to pile up $50,000 in a 401(k) account. When you cash it out, 10 percent of the balance, or $5,000, goes to the IRS in the form of an "early withdrawal penalty" ("early" meaning you're touching that money before the IRS-approved age of 59 and 1/2). An additional $16,000 would go to federal and state taxes, leaving just $29,000, or 58 percent of the total savings in your pocket. Not a great investment move. No wonder over half of those surveyed regretted the decision.

If you're leaving a job, a much better option is to request a rollover into a new tax-deferred retirement account. If you have a new job with a new 401(k), you can ask your HR department for help in doing this. Normally, you'll contact the company that managed your old 401(k), fill out a form authorizing the rollover, and request a check for the amount; you'll have 60 days to deposit this into the new account.

The IRA Option

Anyone, regardless of their employment status, can roll over into an IRA. To do this, first call up a brokerage such as Vanguard or Fidelity, and ask for their help in opening a rollover IRA. With this type of account, you can combine all your old accounts into one new one, which makes it a lot easier to have a properly managed and diversified portfolio. And when you start a new job, you can keep the old rollover IRA, without having to switch again and again.

When you're leaving a job and moving your money around, it's a great time to assess how balanced your portfolio is. Happily, the Employee Benefits Research Institute indicates that fewer folks, like my friend, are significantly overinvested in their own company's stock.

In 2006, average holdings of company stock in 401(k) plans accounted for 11 percent of total assets, down from 19 percent in 1996. However, 11 percent is probably still too much for any one stock. Instead, your portfolio should contain either a good target date fund (the simplest option) or a balance of low-cost index funds. The biggest proportion should be stocks, followed by international stocks, and bonds; in this precarious economy, a small stash of cash is good, too (say, 10 percent).

Many people choose to cash out their 401(k)s because they want to use the cash for something else -- for example, to make a down payment on a house or to pay off other debts. Please don't do this. Try saving and cutting down on other expenses instead. Because it is stashed in a special tax-deferred account to use for retirement, your 401(k) has value that other money doesn't have. One thousand dollars that you put in at age 25 could be worth $29,471 at age 75.

Anything Beats Cashing Out

If you're saddled with high-interest debt, and you've exhausted other money-management options, consider taking a loan from your 401(k) before you simply cash it out. This is not a great solution, but it's better than cashing out because you do pay yourself back.

Rollovers are just one example that the key to success with retirement planning is to keep it simple: have as few accounts as possible, set up painless automatic contributions, and adjust a few times a year.

"I think the biggest hurdle for savings today, especially for young investors, is that they get overwhelmed or they're too busy," says Ragnoni. "It can become relatively painless when you pay yourself first and set it and forget it."

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150 Comments

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  • Yahoo! Finance User - Tuesday, August 5, 2008, 1:19AM ET  Report Abuse

    • Overall: 2/5

    To the "Finance Yahoo User" from August 3 regarding the "Finance Yahoo User" comment from August 1. Sorry to pop your bubble but the August 1 writter is absolutely correct. Money borrowed from a 401k and paid back is NOT taxed twice because it must be assumed that the money used to pay back the loan is the SAME money. Otherwise the borrower just got a block of taxable money that never got taxed! Only someone using Suze Orman type hocus pocus finance for the truly brain dead could envision anything else. The one and only time this money actually gets taxed is when it is ultimately taken as a withdraw, not a loan. The Financial Consultant who also posted on August 3 provides a more detailed explanation and has it exactly right. The lesson here is pretty clear and simple - get your advice from a real professional and run like the plague from the mass media charlatans, the worst of which has to be Suze Orman.

  • Yahoo! Finance User - Sunday, August 3, 2008, 10:35PM ET  Report Abuse

    • Overall: 3/5

    Mediocre advice, but that's what I'm starting to expect from the yahoo finance writing corps. If I wanted information for my 401k that was useful, I'd go to greenestegg.com.

  • Yahoo! Finance User - Sunday, August 3, 2008, 12:24PM ET  Report Abuse

    • Overall: 2/5

    Anya muffed it pretty bad with that "getting a check" to roll over your 401k, but I'm surprised at the "401ks are for suckers" comment. Who are these people? Robert Kyosaki wannabes? At least in my case, I get a 4% match from my company, and at my salary, that's a significant amount of FREE MONEY. And who can't love FREE MONEY??? Geez, folks. People think they can do better than free money and a steady savings rate? Go for it. I got a nice pile of cash waiting for me.

  • Yahoo! Finance User - Sunday, August 3, 2008, 12:16PM ET  Report Abuse

    • Overall: 2/5

    A couple of thoughts. You still have to pay taxes when you take the money out. So if you happen to become unemployed. Pull your 401k money out when your income is extremely low. Only invest in the 401k to the amount that your company will match. Invest everything else on your own. You have to pay taxes regardless.

  • Yahoo! Finance User - Sunday, August 3, 2008, 11:09AM ET  Report Abuse

    • Overall: 1/5

    Just what the world needed - another pop guru with incorrect info like Suze Orman. This article & The Suze Orman show are the best reasons I know to hire a knowlegeable lawyer, accountant or fee-based financial planner. Ms. Kamenetz is a jpurnalist, not a financial consultant. It is sad commentary on the state of financial education in this country that people will listen to a anyonw who can write whether they know anything about the topic or not. Perhaps Ms. Kamenetz missed the jpournalism class on fact checking. 1. Don't ever call your old 401-K trustee and ask for check. By law they must withhold 20% when you get a direct check. You must roll the money in 60 days while the IRS is holing your 20%. If you roll a $100,00 you must find $20,000 out of pocket to make up the difference or the money that went to IRS can't be rolled and you will be taxed and penalized on it. ALWAYS DO A TRUSTEE TO TRUSTEE ROLLOVER TO AVOID THIS PROBLEM. 2. When you borrow tax free money you always put tax free money back. Suppose you borrow the money and lend it to the bank in the form of bank CD. Then you take the tax fee dollars you put in the CD and at maturity pay the 401-K back, it doesn't matter how much you earned inbetween, the dollars you took out are always tax free and tax free dollars always go back. If you give the money to yourself instead of to your bank it is no different. Tax free out, tax free back. The interest you pay, however, will be taxed twice. Suze Orman is wrong on this subject as are many of the posters. Shame on Yahoo! Shame on the US Educational system! Shame on Amy Kamenetz! Sham on Suze Orman! For correct financial & tax advice email FirstInvestorsinfo at Yahoo of course.

  • Yahoo! Finance User - Sunday, August 3, 2008, 10:11AM ET  Report Abuse

    • Overall: 2/5

    The comment left by "Yahoo! Finance User" on August 1 calling someone an idiot should scare everyone on this site. You see, this person THINKS they are correct. When you borrow from your 401(k) it is true that the money is not taxed. You DO pay it back with after tax dollars and you DO get taxed when you start withdrawing it during retirement. So yes, it is indeed taxed TWICE! Use your pea-brain before you call ANYONE an IDIOT!

  • Yahoo! Finance User - Saturday, August 2, 2008, 4:20PM ET  Report Abuse

    • Overall: 2/5

    Actually, agular17 is right ... sort of ... because you're repaying your loan with post-tax dollars and when you make a withdrawal (not a loan) you get taxed on those dollars again (assuming they are pre-tax funds). I said "sort of" because really it's only the interest portion of your repayments that is taxed twice.

  • Yahoo! Finance User - Friday, August 1, 2008, 9:11PM ET  Report Abuse

    • Overall: 1/5

    Paying tax twice on the same dollar?? What an idiot. You took the money out TAX FREE didn't you? Suppose you deposited that TAX FREE money in a ROTH IRA. Think about that. Forget it, I'm sure you would not be able to figure it out.

  • Yahoo! Finance User - Friday, August 1, 2008, 4:44PM ET  Report Abuse

    • Overall: 3/5

    NEVER borrow from your 401k, you are paying yourself back, but with money you paid tax on, when you do take that money back out, will pay taxes AGAIN. You thus pay tax twice on the same dollar.

  • Yahoo! Finance User - Friday, August 1, 2008, 4:42PM ET  Report Abuse

    • Overall: 2/5

    very basic info. unfortunately higher levels of edu DON'T teach to the future financial protection. too much concern today about how much can i make RIGHT NOW! fin advisers and educators need to concentrate on teaching how not to forget about the valleys and peaks of financial planning and planning for the future.

  • Yahoo! Finance User - Friday, August 1, 2008, 1:02PM ET  Report Abuse

    • Overall: 4/5

    Caution Caution Don`t listen to the so calle expert

  • Yahoo! Finance User - Friday, August 1, 2008, 10:57AM ET  Report Abuse

    • Overall: 3/5

    Caution is the right word. If you're young and you're reading this do the following: Cut 10% from your budget, don't borrow money you can't afford, and start saving now. Feed that 401K. Lastly, get the government to act as responsibly as you are. http://nahnopenotquite.wordpress.com/2008/05/23/america-we-cant-afford-it/

  • Yahoo! Finance User - Friday, August 1, 2008, 9:35AM ET  Report Abuse

    • Overall: 4/5

    Re don't cash out that 401k. Don't worry, invvestment planners and brokers will do it for you.

  • Yahoo! Finance User - Thursday, July 31, 2008, 11:28PM ET  Report Abuse

    • Overall: 3/5

    401(k)s are one of the few breaks we get to defer taxes and build up savings for retirement. it never ceases to amaze me at some things you come across on these boards. "401ks are for suckers" "401k investments are ... RISKY". the real problem is that a lot of employees "drink the kool aid" and invest heavily in their company's stock if its publicly traded (see bear stearns et al) and don't follow prudent investment strategies. and if you don't know anything about investing, then speak to a professional. many 401k plans have a "Broker of Record" that works with the employer to select investment options for the plan. you should definately contact that individual if you need help. you can't ever substitue a yahoo blog for sound financial planning or working with an investment advisor. this is a good article that articulates the pitfalls of doing something foolish like cashing out of your 401k when YOU ARE TOLD ABOUT 10 TIMES THROUGHOUT THE PROCESS about the tax ramifications and 10% IRS penalty.

  • Yahoo! Finance User - Thursday, July 31, 2008, 9:53PM ET  Report Abuse

    • Overall: 1/5

    To follow up on the previous comment. If you ask your previous employer to send you a check, they have to keep 20% for taxes, but when you open your new 401(k), YOU need to make up that shortfall. Horrible advice. Horrible advice. This article should be titled, "Caution: Don't Listen To This So-Called Expert."

  • Yahoo! Finance User - Thursday, July 31, 2008, 9:30PM ET  Report Abuse

    • Overall: 1/5

    When you roll over a 401K you never, ever have them send you a check that you personally deposit into your new IRA or new 401K!! The rollover has to be done between your old 401K administrator and your new IRA or 401 Administrator. If you have them send the check to you first they will deduct taxes owed to the IRS and the hassle of getting that money back is incredible. Bad advice.

  • Yahoo! Finance User - Thursday, July 31, 2008, 9:12PM ET  Report Abuse

    • Overall: 1/5

    The one thing you failed to mention is the fact that 401k investments are (not always) but by and large, RISKY...!!!! At or about your retirement age you may have a hefty sum of money only to be hit in the last quarter before you retire, a bomb in the market and take a large loss...!!!!! 401k is not a for sure thing cause it is only as good as the investments that "feed" it.. I had a co-worker take a $35,000 loss one quarter out of a $90,000 account.. it took almost 12 years to get back not even half of that loss.. I feel that 401k's are a "rip" and only benefit the brokers and investment companies as they "skim" of the top for managing the accounts..

  • Yahoo! Finance User - Thursday, July 31, 2008, 9:11PM ET  Report Abuse

    • Overall: 4/5

    This is good advice. Not only does one pay taxes on a withdrawal, but he or she also loses the deferral of taxes on the growth of the money for many years. Better social policy would be to eliminate 401k's and allow everyone to have larger IRA's, but that would be too sensible and simple.

  • Yahoo! Finance User - Thursday, July 31, 2008, 5:21PM ET  Report Abuse

    • Overall: 1/5

    401k's are for suckers

  • Yahoo! Finance User - Thursday, July 31, 2008, 3:18PM ET  Report Abuse

    • Overall: 1/5

    It's absolutely critical going into a recession that people realize that if their debts get too extreme and they are forced into bankruptcy, their retirement accounts generally cannot be touched (each legal situation will vary, however). But in general it's a BAD IDEA to drain or borrow against a 401k or IRA to pay other debts! That's just pouring your good money down the drain after the bad money.

  • Yahoo! Finance User - Thursday, July 31, 2008, 2:55PM ET  Report Abuse

    • Overall: 1/5

    Cash it out. Buy a house. I did, and I have never regretted it.

  • Yahoo! Finance User - Thursday, July 31, 2008, 9:14AM ET  Report Abuse

    • Overall: 1/5

    dumb

  • Yahoo! Finance User - Thursday, July 31, 2008, 8:10AM ET  Report Abuse

    • Overall: 3/5

    If you're young you can keep all options open!

  • Yahoo! Finance User - Wednesday, July 30, 2008, 10:06PM ET  Report Abuse

    • Overall: 1/5

    What bank or Global Funds Corporation paid this woman for this drivel? Yeah, keep that 401K in there, while the management is lousy, and you are losing your shirt to the monthly fees, and remember, you are doing your duty for god and country, as you keep the failed policies of the current administration humming along. Or you can roll it over to your friendly neighborhood banking institution, where some guy whose last job was asking people "do you want fries with that" parks your money into a worthless financial vehicle, that loses it's worth 90 days after you sign the papers. All this to avoid the nasty IRS. Making money is grand. Just make sure the people who print it, don't get their grimy hands on it once you've earned it. BOTTOM LINE: While the market goes up on exuberance again, let's remember the housing market stinks, oil went up $4.00/barrel. We have not seen a bottom, and won't until next year. Reading this post, it should have been followed by I'm John McCain, and I approve of this message. After all, what a better way to promote a failed economic policy. This is what they would like to do to Social Security. Yet the taxpayer only gets taxed by a the financial firm who hold your 401K. The only problem is, your elected officials in Washington are their mercy, and your fees (or taxes...) will be much higher than that of Washington. LOL!

  • Yahoo! Finance User - Wednesday, July 30, 2008, 7:16PM ET  Report Abuse

    • Overall: 4/5

    I agree that this article is elementary, but being a 401k Plan Admin myself, I can assure you that this is a revelation to too many. So this IS a good venue for it. Actually, her article is just the longer version of what I tell ppl on a very regular basis (1-3 times a week). BTW, the 10% penalty assessed for taking an early withdrawal is set in stone--regardless of how low your income goes during unemployment; the penalty is non-negotiable with the IRS--none of it is coming back! Perhaps you won't end up pay taxes on your withdrawal, but the 10% penalty is gone! Ppl just need to THINK and get serious about saving for retirement--for the long term. A 401k is not an account for overdue bills, bdays, Christmas, or personal mrtg bailouts. The taxation and penalties for early withdrawl (hardship or not) are supposed to DETER ppl from taking it out. And yet, the biggest penalty is the one ppl impose upon themselves--that the $50,000 example above will never double to 100k, 200k, 400k, etc... because ppl really needed that measely 29k, today? Live on less. Move out and downsize to affordability. Re-budget, re-train, re-educate; all are cheaper options than cashing out.

  • Yahoo! Finance User - Wednesday, July 30, 2008, 4:58PM ET  Report Abuse

    • Overall: 2/5

    This article is ok. She usually has good info but this article fails to address one of the biggest issues facing most ppl who are cashing out their 401k...it's called economic hardship. ie. losing your job. Ok, so you lost your job, have run through your 6 month emergency fund and now what? Well, your income for this year looks like a drop in the bucket compared to last year and if you have a house and are paying mortgage interest then it's a pretty good chance you'll get a lot of those taxes you paid in penalties back when you file next Spring. I'm not saying its wise to tap the 401k but you really got to look at your own personal situation. Talk to a financial planner. How many other ppl are going to even know about or consider the problem this deeply?

  • Yahoo! Finance User - Wednesday, July 30, 2008, 3:18PM ET  Report Abuse

    • Overall: 1/5

    What? How does a degree in being lazy make you a financial expert? I am not alone in my shock at this nonsense. http://voxbaby.blogspot.com/2006/05/right-way-to-do-unpaid-internships.html

  • Yahoo! Finance User - Wednesday, July 30, 2008, 3:04PM ET  Report Abuse

    • Overall: 5/5

    Anya; you have a good looking picture and seem very mature for 27y/o. You get my vote for hot financial women.

  • Yahoo! Finance User - Wednesday, July 30, 2008, 2:35PM ET  Report Abuse

    • Overall: 1/5

    We all know that cashing out 401K monies is a bad thing to do financially. Why doesn't Ms. Kamenetz provide some examples of how you can deal with the tax implications by way of deductions etc. for those who have cashed out, rather than repeat what has been written in countless other articles on this subject?

  • Yahoo! Finance User - Wednesday, July 30, 2008, 2:28PM ET  Report Abuse

    • Overall: 4/5

    funny thing... i have talked to more baby boomers who are nervous as a long-tailed cat near a rocking chair and they say the same thing... STAY THE COURSE ... you will be just FINE.. txs... lou

Showing comments 6-35 of 150<< PreviousNext >>

More from Anya Kamenetz

Read the Generation Debt Book

According to economics professor Laurence J. Kotlikoff, Generation Debt offers "a truly gripping account of how young Americans are being ground down by low wages, high taxes, huge student loans, sky-high housing prices, not to mention the impending retirement of their baby boomer parents." Generation Debt will inspire you to take charge of your financial future.

Read more from Anya Kamenetz here and here.

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