Should You Cash Out Your 401(k) After Leaving a Job?

Data compiled by the Harvard Business Review found that 41% of U.S. employees cashed out some or all of their 401(k) funds upon leaving their employer. Of those who did cash out their 401(k) when changing jobs, a staggering 85% drained the entire balance of their 401(k) accounts on their way out the door. Here’s why that’s a bad idea — and what you should do instead.

The Importance of Your Retirement Plan

By the time you retire, you’ll have spent decades working. While the idea of saving for a goal that’s 10, 25 or even 40 years away often doesn’t have a lot of appeal, it’s an essential component of living well during your golden years. That’s why retirement savings accounts like 401(k)s are designed to keep your money invested until you hit a certain age, but because the United States is the only developed economy that permits companies to give the cash-out option to departing workers, many Americans cash out their retirement plans too soon and then find themselves struggling to make ends meet as they age. 

Options When You Leave Your Job

Whenever you experience a career change, you have the opportunity to make a decision about funds in your old employer-sponsored retirement plan. Depending on the situation, you generally have four options:

1. Leave the funds with your former employer’s plan
2. Transfer your funds to an employer-sponsored plan at your new workplace
3. Rollover your funds to an IRA 
4. Withdraw all the money

If you’re not at retirement age, any of the first three options that leaves the money invested is the best way to prepare for your future.

The Implications of Cashing Out a 401(k) When Changing Jobs

When you’re out of work, it can be tempting to tap into the savings you’ve accrued, especially if some of the money in your 401(k) came from an employer-offered 401(k) matching program. However, experts say this type of withdrawal should only be used as a last resort, as these accounts were created to be long-term savings vehicles for retirement. If you take an early withdrawal from a retirement plan, like an IRA or a 401(k), before you reach age 59 1/2, and you don’t meet the requirements for an exception – such as having a permanent disability or paying for unreimbursed medical expenses –  you will likely have to pay an additional 10% early withdrawal penalty on distributions made before retirement age. Early withdrawals also count as taxable income, so you will have to pay income tax on the amount cashed out in addition to the 10% penalty. But perhaps the most detrimental aspect of a 401(k) cash out after leaving your job is that you’re taking money away from your future self. 

While you may be able to borrow against your 401(k) and repay that money over five years, you should avoid leveraging this option. You will be required to pay back interest and fees, and you’ll also lose the growth you would have seen in your retirement account over that time.

Retirement is expensive; on average, people are living approximately twenty years after they retire and will need to replace 55-80% of their pre-retirement income for each year. Add in the impact of inflation, and you’re looking at needing a sizeable nest egg.   

What to Do With Your 401(k) After Leaving a Job

Every year retirement funds are lost or abandoned when people leave their old employers. Instead of cashing out, evaluate whether you should keep your assets in your current plan, transfer assets to your new employers’ plan or rollover your balance to an IRA.  If you’re not sure what option would be best for you, contact a Farm Bureau agent or financial advisor. We can help you make decisions about how to put your money to work and then can take action on those decisions, ensuring you are making progress toward your retirement.