Young workers still foolishly cashing out 401 (k) accounts

NEW YORK – One of the biggest mistakes young workers can make is to cash out their retirement account when they leave a job.

They not only have to pay taxes on the money, along with a 10 percent penalty, but they also lose all the future earnings that could provide income in retirement.

Still, more than eight in 10 young workers take their money and run, mainly because they have small balances in their 401(k) retirement accounts and don’t take the time to study their options.

“There are two problems,” said Greg McBride, a senior financial analyst at Bankrate.com in North Palm Beach, Fla. “They don’t see it as a lot of money, and they don’t think long-term.”

He points out that even a balance of $2,000 invested at 8 percent would be worth nearly $22,000 in 30 years, thanks to compounding.

“So young workers who cash out are robbing themselves of a lot of money for retirement,” McBride said.

Now the federal government is moving to make it easier for workers to preserve small accounts, and some retirement plans are developing new procedures to help, too.

The way the system works now, departing workers with 401l(k) balances of $5,000 or more have several options to preserve their retirement money. They can leave the money in their former employer’s 401(k) account, they can transfer it to an Individual Retirement Account or they can move it to their new employer’s 401(k) account.

Workers with smaller balances have the option of opening an IRA or rolling the money into a new employer’s 401(k) program. But under current federal rules, if they don’t give their former employers instructions about what to do with the money, the employers can simply send them a check, and that’s what the majority do.

“In other words, inertia generates a cash-out,” said David Wray, president of the Profit Sharing/401(k) Council of America trade group based in Chicago.

That’s going to change under a Labor Department regulation announced Sept. 28 and effective next March 28.

Under the new rule, if a departing employee has accumulated between $1,000 and $5,000 and gives no instructions about rolling it over, the employer can keep the money in its plan until the person is 65 or can put the money into a special rollover IRA maintained in the employee’s name.

“Now more of this money will be preserved,” Wray said. “And we think that’s a very good idea.”

Wray said that one advantage of keeping young people invested for retirement is what he calls the “life-altering effect of early savings.”

As he put it: “Most young people think they can’t save, but if they start putting something – anything – into that 401(k) and get that employers’ match, they can have $20,000 or $30,000 fairly quickly. And that changes their vision of what they can do.”

Aware of the problem, some major 401(k) providers have begun developing programs to make it easy for departing workers to roll their funds into an IRA, sometimes even offering to carry over the mutual funds they’ve invested in.

Darwin K. Abrahamson, chief executive of Invest n Retire LLC in Portland, Ore., which provides Web-based services for 401(k) plans, sees cash-outs by young people as one of the biggest problems facing the industry.