By Craig Erwin, Ph.D.
CASHING OUT MAY SEEM TRIVIAL, BUT IT’S A BIG DEAL
It’s the little things that count, especially when saving for retirement. If you increase the amount you save per paycheck by a little bit, you will accumulate far more money. If you make your own lunch or brew your own coffee, the savings also pile up. If you change jobs, your old employer may allow you to keep your money in their retirement plan, but you can also roll the funds over to an existing Individual Retirement Account (IRA), or you can start a new IRA. You can also take the money and run, cashing out and pocketing the cash.
A study conducted by Rob Austin, Anthony DePalma, and Landis Cullen found that 80% of people changing jobs, with a retirement savings plan account balance less than $1000, cashed out, pocketing the cash. They also found that 62% with a balance under $5000 cashed out when changing jobs. Some employers automatically cash you out when you leave, if you have a balance under $1000. You might think it doesn’t matter what you do with such a small balance, but you’d be wrong.
If you cash out when the account balance is small, say under $1000, does it really affect how much money you accumulate? Yes. In fact, Austin, DePalma, and Cullen found that cashing out can make a big difference in the amount you accumulate for retirement. They examined what would happen if a worker saved from the age of 22 to 67 (retiring at 67) with a 5% interest rate and with her employer matching her contributions at a 50% rate (contributing 50 cents for every dollar she saved). Assuming no cash-outs, the total amount she would accumulate by age 67 would be $484,000. Not bad, huh? But if she cashed out $3000 at age 24, it would cut her savings at retirement by $23,000. That stings. If she then made two additional cash-outs, things could really get painful. For example, if she cashed out $4,500 at age 26 and $5000 at age 28, she would end up with $91,000 less than if she had not made any cash-outs. Instead of ending up with $484,000, she would end up with $393,000when she retires. Now, that’s a painful loss. Think of what you could do with $91,000, even though inflation would reduce its purchasing power.
The example above assumes a 5% interest rate or return on your savings. If you earn a higher return on your savings, as you might in a stock index mutual fund, cash-outs are even more devastating, taking an even bigger bite out of your savings. So, if you change jobs, don’t even think about cashing out. Make sure that money stays untouched until you retire, so you can have the maximum retirement savings. And if your employer cashes you out when you leave, don’t spend the money; roll it over by starting an IRA or adding it to an existing IRA. Cashing out may give you a little pleasure now, but wouldn’t you rather have greater peace of mind in the future.
Have you ever cashed out? If so, do you wish you hadn’t? Are you enrolled in a retirement savings plan? If so, are you concerned that you may not be saving enough?
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