Hewitt Associates, the same company that processes my company’s accounts payable, has performed a survey regarding 401(k)s. They discovered that almost half of workers leaving their jobs convert their 401(k)s to cash.
This is despite the fact that in addition to income tax, there is a steep penalty (10%) for cashing out the tax-deferred retirement savings. Most of those who cashed out their 401(k) had balances of less than $10,000, so we’re not talking about a large sum of money.
If I leave this company and move to another, I will roll my almost $20,000 in my 401(k) over to one offered by my new company if the investment choices are decent. Otherwise, I will leave my 401(k) where it is. I am currently investing enough to take full advantage of my company’s 4 percent match.
In addition, I’m investing the full amount ($4,000 this year) in a Roth IRA. I invest this money in the TIAA-Cref index fund. There was no minimum to open the account (with an automatic systematic investment) and the fees are very low.
Next year, my company will likely have an option for the new Roth 401(k), depending on the fees. This new investment option is similar to the Roth IRA as the money invested has already been taxed and the funds can grow unencumbered by additional taxes.
What about 401(k) loans? Well, I’ve mentioned this before and generally think it’s a bad idea. Although there’s debate as to whether your funds will be “taxed twice” once you pay your loan back and later take distributions (you’re paying the loan back with after tax money and you pay income tax on those same funds when you take the distribution) there are still negative points to consider.
You’ll lose whatever compounding growth on the money you take out for the loan, the loan could become due immediately in some circumstances, and there can be penalty fees if you can’t pay the loan back for some reason.
The best solution is to just let your funds stay in the 401(k) unless something better becomes available after leaving the job.
Updated February 6, 2012 and originally published July 25, 2005. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @flexo on Twitter and visit our Facebook page for more updates.