A surprising number of Americans make the same mistake when changing jobs, putting their financial future in jeopardy.
According to a UBC Sauder School of Business study, just over two in five (41.4%) employees choose to cash out their defined contribution 401(k) plans early.
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This type of account can be relied on, retirement savings tools For millions of Americans, the researchers who wrote the UBC Sauder survey believe the difficult trade-offs around career transitions are driving workers to dive into these vital funds out of their 401(k)s. I’m here.
But cashing out your 401(k) early is something personal finance professionals should consider, whether it’s because you’re changing employers or because you desperately need the money. one of the worst financial failuresHere’s why it drives professionals crazy and what to do instead.
What are you risking by cashing out your 401(k) early?
UBC study used a data set of 162,360 retired employee contribution records from 28 employers and 28 retirement plans.
Of the 41.4% of workers who pulled out their retirement savings, about 85% completely depleted their accounts. 64% made her one-time cash withdrawal, and 21% said he used up his 401(k) balance with two or more withdrawals within eight months.
Cashing out your 401(k) early is problematic for multiple reasons: you have to pay taxes and fines, you lose the benefits of compounding interest, and you may not be able to pay it in the end. save enough money to retire.
It also creates a larger systemic problem, said Yanwen Wang, an associate professor at UBC Souder. This is because his 401(k) contributions from currently employed employees will be used for retirement funds. When these funds “leak” out of the system, everyone’s retirement security is jeopardized.
To discourage people from cashing out before the legal age of 59.5, the Internal Revenue Service (IRS) has imposed a 10% fine for what they call “pre-retirement leaks.” I’m here.
The three main causes of leakage are: Default on loans from retirement accounts. Hardships in service and withdrawal without hardships. Cash distribution at retirement.
Prior to the COVID-19 pandemic, approximately one-third of 401(k) leaks were due to emergencies. Retirement ClearinghouseMost people cashed out due to the “friction” and lack of education in the 401(k) rollover procedure.
But when many Americans lost their jobs during the pandemic, the CARES Act temporarily waived penalties for leaks of up to $100,000, but the expected wave of withdrawals never came. In fact, economic well-being and Participation in retirement plans has actually increased During a pandemic due to reduced government support and spending.
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Why Do Americans Withdraw Retirement Money?
If it’s not necessary, what’s causing the leaks? From a perceptually illiquid source of late guarantees to a psychologically liquid pile of cash.”
In other words, your hard-earned retirement money turns into an easy-to-use, attractive windfall fund. currently looking for a job And I don’t have a stable source of income.
Research shows that this mindset often comes to the fore when employers offer generous 401(k) matching programs to help employees significantly increase their retirement finances.
“For example, if your employer matches you 1-for-2, for every $1 you donate your employer matches $2, it can change the psychological ownership of your 401(k) account. Yes,” Wang said. – Authored a study with Muxin Zhai of Texas State University and his John G. Lynch, Jr. of the University of Colorado.
“So instead of money you’ve saved yourself, it’s like a windfall. And it feels more touchable and more justified to spend it when changing jobs.”
What should I do instead of cashing out?
The average worker has 12.4 jobs in their career, according to the Bureau of Labor Statistics, but that doesn’t mean you have to cash out a 401(k) every time you move. You can either leave it in your master’s plan or transfer your assets to your new employer’s plan.
or change the balance to Individual Retirement Account (IRA) You can continue to grow your retirement savings tax-free until you withdraw at retirement.
IRAs are playing an increasingly important role in helping Americans save for retirement, especially as workers change jobs more frequently throughout their careers.
More than 4 in 10 U.S. households will own an IRA by mid-2022, according to ICI studyWith $11.7 trillion in assets, the IRA accounts for 34% of total US retirement market assets, compared with 24% 20 years ago and 18% 30 years ago.
But Wang said Americans need to be more educated about the benefits of 401(k) rollovers and the consequences of cashing out.
“When there is no support for employees to quit, they are unintentionally encouraged to withdraw money, especially if there are large matches,” Wang said.
“Something has to be done not to control people’s 401(k)s, but to provide them with enough knowledge so that they can recognize the consequences of their actions.”
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This article is for informational purposes only and should not be construed as advice. It is provided without warranty of any kind.