Do Not Cash Out Your 401(k) Account

This message is for baby boomers who have not retired and in particular for those who have not reached 59  1/2 years of age.

Stop cashing out those 401(k) accounts!

According to a recent survey by Hewitt Associates, 46% of those persons who changed jobs or lost their jobs in 2008 took the cash out of their 401(k) accounts. Even for those in the age groups 40-49 and 50-59, the cash-out rates were 43% and 34% respectively. That is a terrible statistic. Yes I know that they think they need the money then, but not as much as they will need the money when they retire. This sad trend by the way did not begin with the current economic crisis. The cash-out data has remained stable since 2005.

Baby boomers (ages 55-64) have been doing an awful job of exploiting tax-advantaged retirement plans. In fact, a study done by the Boston College Center for Retirement Research showed that 401(k) and IRA accounts represent just 7%  of their retirement wealth. This compares to 20% represented by the value of their primary residence. Of course, that data is from 2007 and we know what has happened to real estate values since then.

The knee-jerk reaction to this information is to blame the 401(k) plan for the early withdrawals. I disagree. The real problem is lack of financial discipline. Too many folks treat their retirement accounts as a “rainy day” fund. They use their departure from one employer – even just to take another job – as an excuse to raid their 401(k) account. Unless they have reached the magic age of 59 1/2, the 10% early withdrawal penalty and taxes will take a huge bite out of that money.

Baby boomers who withdrew 401(k) cash (or stopped contributing) also suffered by losing out on the stock market rebound since March 2009. This data from the Employee Benefit Research Institute show declining average 401(k) balances for many folks in the 45-54 and 55-64 age groups since January 2008 whereas the accounts of younger employees did much better.

What are folks doing with this 401(k) cash out money?  An earlier study by the Employee Benefit Research Institute found that while many just “spent it” , even more used it to pay down debt, buy a house, or start a business. These don’t sound like hardship withdrawals to me.

I suppose from these numbers you could conclude that there is at least one thing wrong with 401(k) plans. They make it too easy for employees to get at their accounts before they retire.

Think about this before cashing out that 401(k) account fellow baby boomers: The pain of financial discipline is much less than the pain of retirement (or unretirement) regret.

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