You've probably heard this advice before -- that it's generally not smart to cash out your 401(k) account when you switch jobs. It's easy, yes, to tell your soon-to-be-former employer to just cut you a check. But it can really cost you.
To find out just how costly cashing out can be, you have to consider several factors:
Unfortunately, the biggest hit for those who decide to cash out comes from tax and penalties. The penalties alone are generally a whopping 10% of your account's balance! And the taxes can be 30% or more, depending on your bracket. In contrast, you can earn a lot more by rolling over the account into an IRA and leaving it to grow.
See for yourself
Here's an example: Let's say I'm 45, plan to retire at 65, have $50,000 in my 401(k) plan, and expect to earn 8% over the long haul:
Whoa! Where did that $233,000 come from? Well, it reflects what that $50,000 will grow to if you roll it over.
It's not quite a fair comparison, though. Because you get the $30,000 now, and the $233,000 in 20 years. You may well be planning to invest that $30,000 for 20 years.
But get this: Say you do invest that money, and you earn even more than you expected -- let's say 10% instead of the 8%. You still end up with only $202,000. That's less than what you'd have by rolling over, despite the extra return.
Maximize your odds
Fine, you say. I'll just earn enough to turn my $30,000 into $233,000. Well, an average annual gain of 11% would do it, but that's easier said than done. You can invest in big names that you know well and still get mixed results. Check out these numbers:
Company
20-year average annual return
Limited Brands (NYSE: LTD)
4.7%
Pitney Bowes (NYSE: PBI)
6.6%
American Express (NYSE: AXP)
6.7%
General Electric (NYSE: GE) Continued... |