By JLP | July 13, 2008
Check out this quote from a recent Wall Street Journal article by Andrea Coombes:
…about 40% of workers in their 20s and 30s said they had cashed out their 401(k)s or 403(b)s when they switched jobs, according to an online survey of about 1,200 people conducted in January for Fidelity Investments by CMI, a research firm.
You quit your job and take a new job with a different company. You have $800 in your old company’s 401(k) plan (you had just started contributing). Do you:
1. Move the money to your new company’s 401(k) plan?
2. Move it to an IRA?
3. Cash it out because it’s such a small amount of money?
Of course options 1 and 2 are the best. Number 3 is the worst. But, how bad is it?
Well, for starters, your employer will have to withhold 20% of your $800 for income taxes. You will also lose another 10% due to the IRS’s early withdrawal penalty. So, your $800 becomes $560 by the time you actually receive it.
Now, what’s the opportunity cost for cashing out your 401(k)? As you can see from the following graphic, it can be a significant amount over a long period of time:
Don’t underestimate the potential growth of a small amount of money! Instead of looking at $800 as a small amount of money now, consider it’s future value if invested properly. And, if there’s ever a time when you are tempted to cash out your 401(k) in order to pay bills, fix your car, or take a vacation, PLEASE re-read this post!