Investing

The most expensive mistake you can make with your 401(k) when you change jobs

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Moving to a different job is a reliable way to make more money in this economy, experts say. But when you switch jobs, you might be offered the opportunity to cash out your retirement account.

Withdrawing money early from retirement accounts is a widespread issue: One in 3 investors has cashed out a 401(k) before reaching retirement age, according to data from Fidelity.

"There's a lot of money that leaves prematurely, before retirement, where the government collects a penalty," says Sri Reddy, senior vice president in retirement and income solutions at Principal. "And it often happens in plans with the lowest amounts."

Early withdrawals are expensive: Depending on the account and circumstances, you'll owe taxes and a 10% penalty. On top of that, there's an opportunity cost, since those dollars are no longer compounding toward your retirement goal.

The average cash-out is $14,300 for those under age 40 who are switching jobs, according to Fidelity. After taxes and penalties, someone in the 22% tax bracket could walk away with less than $9,000. But if that money were instead left to compound for 25 years at an average annual rate of return of 7%, it could grow to more than $77,000 by retirement.

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What to do with your 401(k) when changing jobs

Say you find yourself in a position in which you have a small amount of money in a qualified retirement account and are faced with a choice of what to do next after leaving your job. Typically, you may have the following options:

  • Keep the money in your old employer's plan
  • Roll the money over into a new account (either your new employer's 401(k) plan or an IRA)
  • Withdraw the money

Your first step is figuring out which of those options are available to you. For example, your old employer may not let you keep your money in its plan if your balance is less than $5,000, or your new company many not accept a rollover.

Then figure out which option is the best choice for your situation. Fees and investment options vary, so you'll want to put some thought into your next move.

Reddy recommends keeping your money where it is, if possible. "If your employer lets you keep it there, keep it there," says he says. "Otherwise, find a low-cost IRA."

This graphics shows that the average overall 401(K) balance is $106,000 and breaks the averages down by demographics.

Average 401(k) balances are a little more than $100,000, which is likely a lot less than what you'll need to get by comfortably in retirement. For that reason, it's especially important to make sure you're sticking to a predetermined strategy of saving and investing for the long term and allowing your money to grow.

Take your money out early, though, and you probably won't be doing yourself any favors. "If you're paying a 10% penalty, and you don't have that much to begin with," says Reddy, "is that really good for you?"

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