This is a guest post from Dawn of Frugal for Life. If you like what you see here, please consider subscribing to her RSS feed.
I’ve twice been given the opportunity to rollover my 401(k) instead of cashing it out, and I’ve twice failed to do so. In both cases, I mistakenly placed today’s concerns ahead of those of tomorrow.
Cashing out my 401(k)
The first time I cashed out my 401(k), I had accumulated a little over $5, 000 before taxes and penalties. If I recall correctly, I used that money to pay off debt and buy a new washer and dryer.
Unfortunately, I didn’t hold back enough to cover my state and federal taxes, so I had trouble paying my taxes when they came due and had to set up a payment plan. This left a sour taste in my mouth, and I vowed never to make that mistake again.
The second time I cashed out my 401(k), I had accumulated a little over $2000, and once again felt that debt reduction was more important than the long-term goal of retirement. This time around I tried to hold back more for taxes, but once again fell short. Once again, I had to set up payments to the IRS to pay what I owed.
Starting fresh
With a new job and a fresh outlook, my 401(k) has once again started to grow. Moreover, I no longer review my retirement money as an expensive savings account. I’ve learned from my past mistakes, and now consider my 401(k) to be untouchable, off-limits until I retire.
Looking back, I estimate that I’d have over $10k in an IRA if I had just rolled my 401(k) money instead of withdrawing it. Instead, I have a washer and dryer that are not aging well and a few debts that were paid off, but have since grown back.
When the time comes for me to move from this company to another, I will not hesitate to roll my 401(k) into an IRA. When I do this, it will happen electronically so I don’t ever see a check. Unfortunately, I’m just now learning this at 36 years of age, but starting over now is better than never starting at all.
Lessons learned
My experiences have taught me the following:
- Retirement savings, no matter how meager, do add up
- Never pass up matching contributions from your employer
- Always check the fees associated with your investments
- Be an active participant, and move your money if necessary
I also try to imagine myself at 67 as I’m putting the money away.
Hopefully you’ll learn from these mistakes instead of making them yourself.
After reading your “lessons learned” I think that you may have missed one: Stop getting into debt! Then you won’t be so tempted to blow your retirement on paying off debt, because you won’t have any!
People live their lives on debt: credit cards, mortgages, car payments, gambling, etc. Debt service (interest) can easily siphon off 30% of your money over the life of a loan just so you can have more “stuff” now rather than later, when you can afford to pay cash. Don’t get stuck in that rut!
Right now, I am working less because of grad school (working towards MBA and CPA license). We also have a child. Between child tax credit, daycare expenses, FSA, and education tax credits, our tax liability is very low.
When my company announced that they were dropping the 401k match to 10%, it only made sense to forgo the match and put exclusively into the Roth. To make thing worse, the match is only made as the end of the fiscal year (end of January) and only if you are working there at that time. There is a good chance that I will not be working there then.
The Bear,
By “giving up the tax deferral” I mean you are paying current taxes on contributions to a Roth, instead of deferring them through a regular 401k. I was not referencing the sheltering of taxes once the money is in either of the aforementioned plans.
Since when was a Roth 401k not tax deferred? The idea with a Roth anything is that you put money in after-tax, it grows tax-free, and it is not taxed when you take the money out. With a traditional (Ira or 401k) money is put in pre-taxed but is taxed when you take distributions.
Yes, I am giving up my company’s 10% match. I am also giving up any tax savings for this year (my tax bracket is closer to 15-20%). When I retire, I expect to have a large next egg and I expect that income taxes will be the same or higher than today. So I am giving up a 30% savings now for a savings of 35% or more when I am retired.
The Bear,
Your math doesn’t really add up. By giving up your company’s match you are: 1.) Giving up an instant 10% return on your money and 2.) by adding to a Roth you are giving up the tax deferral which means your investment starts off with a -10% to -%30 return because of the taxes being taken out. Add the impact off the lost match and taxes and your Roth is starting off with a -20% to -40% loss! Don’t get me wrong, a Roth IRA is a great idea for many people. But the math is very important to understand.
Thank you all for your input.
I just rolled over my 401k into an IRA w/Vanguard and am pretty happy — more choices, lower fees, and plenty of room to grow.
I too don’t touch my 401k..
I’m 27 years old.. and started my 401k with my current company at 19 years old..
Until recently I was putting 2% in (and about 2 years ago I upped that to 5, and now it’s at 10%) with a little over 40k in right now.
This is different from personal investment accounts and I do plan on rolling 20% of it into an IRA when I reach the 50k mark in the 401k. Just because I’d like to make a few more “high risk” plays since I’m still young.
I don’t plan on touching it until my 60’s (unless my emergency fund dies out due to unforeseen circumstances).
Great post btw.. we learn best from our mistakes
Dawn–The last line of the post was the brightest gem in the post, “I also try to imagine myself at 67 as I’m putting the money away.”
That is an incredible visualization!
Two comments here…
There seems to be a tendency to cash out a retirement plan if it’s less than $10,000. Maybe we can’t conceive of a $5000 balance growing into anything meaningful in the future, so somehow immediate concerns win out.
Also, a lot of plans are being cashed out now because millions of people are becoming unemployed with no immediate place to go. Long term it may not be a sound strategy, but in the short run the bills have to be paid. It’s hard to think long term when the bill collectors are at the door and regular savings have already been drained.
Though I agree with you that cashing out for preference purchases is a bad idea, there maybe times when liquidating a plan is entirely rational.
Always and never are two words always to be careful never to use. My current employer announced that matching contributions would be dropped to 10% beginning this year. In the past, the match was 33 1/3% to 100% percent, depending on company earnings. For the past two years, it was the minimum. Now at 10%, I am much better off to fore go the match and just put it into a Roth 401k so that I will not have to pay taxes on my distributions. As long as my tax rate is over 10%, then foregoing my employers match is a good idea.
1. Bingo Ditto on “Evolution’s” comments above!
2. Anyone who reads anything about Money – MUST read the book Evolution of Wealth; it is “actual truth”…
3. An actual example of an Opportunity that justified taking retirement out; in ’74, my wife took her $2.7K retirement from 5 years of teaching and we used it as the downpayment for a new $32K townhouse which we sold for $57K three years later when moving up to a SF Home. In ’02 we bought back the “5 years of retirement work credit” for just $16K. Oh, and we just settled on our $1.2M Retirement Dream house on a mountaintop in Western N.C with less than a $200K mortgage. No Lesson (including this one) is “Always and Forever” – always know your current real options and risks.
Opportunity cost. That’s the biggest eroding factor that you didn’t mention. What was and is the opportunity cost of the money that you should currently have in your 401k?
Better yet…did you make these decisions on your own? If so, did you do research into the matter? Was there any comparison done between the scenarios you were contemplating?
If someone helped you with these decisions, who was it? Were they qualified to help? How did they help?