Please don't cash out your 401k

What’s the best type of 401k to have? One that you don’t cash out when you lose your job or move on to the next one.

• Bing: Best 401k plans

A new survey by Hewitt Associates of 170,000 people whose employment changed last year showed that 46% did in fact cash out -- and the percentage was higher among the youngest investors. The amount they lost to taxes and early-withdrawal penalties -- often 30% or more -- apparently wasn’t a disincentive. And neither was the loss of substantial compound interest over time.

The Associated Press said:

An employee who cashes out a $5,000 retirement balance at age 25 would get a check for just $3,500 after taxes and penalties. Left in an account, that $5,000 may have grown over decades to $75,000 at retirement, Hewitt said.

Why is this happening, even though it’s one of the worst personal-finance moves you can make? Two explanations come to mind immediately.

• People don’t understand the purpose of retirement funds. They aren’t fun money, your new-car account, or an emergency fund to keep up your lifestyle until you get your next job. With the near extinction of the traditional pension plan, 401ks, IRAs and other retirement accounts will make the difference between a comfortable retirement and one in near poverty.
• Young people have trouble anticipating life in old age. That’s perfectly understandable: As the 55th birthday approaches, I’m pretty amazed that I’ve lived this long.

The AP story observes that the 401k has fallen out of favor with some -- partly because it’s so often misused (read: cashed out) and also because of the risk involved. Anyone with a 401k knows what last year’s stock market did to retirement savings.

But the fact is that for most workers, a 401k is still the best savings plan. So, what should you do with that money if you’re leaving your job?

• Leave it where it is, which you can do if your account is $5,000 or more.
• Move it into your new employer’s plan.
• Roll it over into an IRA.

Here’s what David Weliver at Money Under 30 recommends:

If you’re looking for the convenience of one account for all of your retirement savings, roll your 401k to your new employer’s plan (that’s assuming you  have a new job, we’ll add). If you want more control over your investments and don’t mind having two accounts, roll the 401k balance to a traditional IRA.

Related reading:

• Do 401k plans still make sense?
• Workers step up raids on 401ks
• Leaving a job? What about that 401k?