Tuesday, July 29, 2008
Latest Yahoo Column: Don't Cash Out Your 401(k)
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.
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3 comments:
The simplest thing to do is select your own IRA provider early on and then continually roll your 401k's over when you move on to your next job. In a lot of cases, the IRA provider will do most if not all of the work for you. Whatever you do, don't just sign on with whomever your company chose as their 401k provider. A lot of companies' goal when choosing this provider is to lower the company's cost, not in providing you well rounded options. (If the majority of your fund expenses exceed 1%, you probably work for one of those companies.) Stick with the classic providers, Vanguard, T Rowe Price, or Fidelity and it will be hard to go wrong. Just make sure you chose the funds that are right for you, not just what happened to be in your last company's 401k plan.
"cashing out a 401(k)... what a dumb idea!... oh wait, I did that." interning summers during college for a place that offered 401(k) matches, I enrolled in the 401(k) just for the match money an then pulled it out (needed beer money/student loans to pay)... I wonder how many people did what I did, and how the statistics would change if they thresholded the withdrawls "how many folks withdrew 5K or more".
It's a good idea to cash out of your 401(k) only if the taxes and penalties you'd pay are less than the taxes you'd pay once retired and taking distributions from what would most likely be an IRA (most 401k's eventually are rolled over into IRAs during one's retirement years).
For example, if you leave a job in February when you didn't work a lot and any income you have will be tax-free because of personal deductions and exemptions, then cashing out of the 401(k) and paying the 10% penalty may mean that it is beneficial to you.
It all depends upon the amount you cash out (which will become taxable income), whether you'll go back to work and have more taxable income during the same tax year, and what bracket you are currently in.
If it is beneficial, then the after-tax proceeds can be taken and put in, say, a tax-deferred annuity in which any growth will be shielded from taxes until taken out. Better yet, put the proceeds into a Roth IRA to the maximum allowed.
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