Half of Laid-Off Workers Raid 401(k)s

Young workers and those with small 401(k) balances are most likely to take the cash and pay hefty penalties

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Almost half of laid-off workers succumbed to the temptation of spending their retirement stash last year. Some 46 percent of retirement savers who left their job in 2008 cashed out their 401(k), according to a new Hewitt Associates study of 170,000 401(k) participants who terminated employment last year. The rest kept their savings in their prior employer’s 401(k) plan (29 percent) or rolled the money over into an IRA or a new employer’s 401(k) plan (25 percent).

[See 7 Things to Consider Before You Move Your Nest Egg into an IRA.]

Workers with small 401(k) balances were the most likely to raid their retirement account. Some 85 percent of retirement savers with balances under $1,000 cashed out or were forced out of the plan due to low balance provisions and 45 percent of employees with between $1,000 and $5,000 saved for retirement withdrew the cash. More diligent savers generally left their retirement stash to further accumulate, tax deferred. Just 17 percent of workers with between $20,000 and $99,999 in their retirement account requested a cash distribution and only 8 percent of those with 6 figures accumulated cashed out.

[See 5 Ways to Protect Your 401(k) if You're Laid Off.]

Younger employees also tended to withdraw the cash and pay the resulting penalties when they left a job. Some 60 percent of 20-something employees took a cash distribution from their 401(k) compared to 34 percent of those in their 50s. But 20-somethings give up a huge amount of compounding interest when they cash out even small balances. For example, an employee who cashes out $5,000 from a 401(k) at age 25 will receive just $3,500 after paying a 10 percent early withdrawal penalty and income tax, assuming the worker is in the 20 percent tax bracket. If the same worker simply left that $5,000 in a tax-deferred account and earned a 7 percent return annually, he would have $75,000 at age 65, according to Hewitt calculations.

[See IRA and 403(b) Owners Pay Higher Fees than 401(k) Savers.]

Workers of all ages who didn’t cash out their retirement accounts when leaving a job were equally as likely to leave their nest egg with their old employer as to roll it over into a new tax-deferred account.