Those who cash out 401(k) plans are at risk

updated 7:51 p.m. ET Oct. 28, 2009

DES MOINES, Iowa - Millions of workers take a huge chance with their retirement savings every year: They cash out their 401(k) accounts when they lose their jobs or move to new employers.

When people cash out, a chunk of their money just disappears.

Employers and financial advisers have warned workers about the possibility of retiring poor, something that's more likely to happen when people cash out their accounts. The rhetoric to keep saving ratcheted higher over the past year as stock prices fell and the average retirement account balance fell by a third.

But a recent study shows that workers are ignoring the advice — the rate of cashing out has been stable since 2005.

Business consultant Hewitt Associates looked at the behavior of 170,000 401(k) participants who left jobs last year. The review shows that 46 percent of those changing or losing their jobs took the cash out of their accounts. A quarter of the workers either rolled over their money to individual retirement accounts or other retirement plans and about a third kept the money in their previous employers' 401(k) plans.

The fact that people are cashing out at such high rates does not bode well for future retirees, said Pamela Hess, Hewitt's director of retirement research.

"Millions of Americans who rely on defined contribution plans will find themselves unable to achieve a financially secure retirement," she said.

The trend is even worse among workers in their 20s. The problem with those workers taking out their money is that they miss out on decades of tax deferred growth and the benefit of compound interest on their investment.

An employee who cashes out a $5,000 retirement balance at age 25 would get a check for just $3,500 after taxes and penalties. Left in an account, that $5,000 may have grown over decades to $75,000 at retirement, Hewitt said.

Jeremy Caverly, 29, of Silver Springs, Md., learned the hard way that cashing out doesn't pay.

He took out his 401(k) money when he was in his early 20s. After receiving a job offer, he gave his employer four weeks notice. However, two weeks later the offer was rescinded and he was left without a job. He saw the thousands of dollars in his 401(k) as a way to get him by until he found work again.

He ended up with about $10,000 from the account. Some of it he spent on a planned trip with friends and some was used for expenses until he found a job about three months later. He had some left over and put it in a savings account.

He said he was horrified by the 30 percent in upfront taxes and a penalties that shaved thousands of dollars off the top of his savings. To make matters worse, he received a bill from the IRS for thousands of dollars in additional taxes due on the cash, which was considered income that year.

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