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Don't Cash Out That 401(k)!

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For those who hope younger generations will be smart with their money, the bad news continues. According to a Fidelity Investments survey from last year, roughly 40% of workers in their 20s and 30s cash out their 401(k)s or 403(b)s when they switch jobs.

Yowza! Clearly, financial illiteracy remains a big problem in America. If these folks knew more about the importance of saving and investing and about how money grows, they'd behave differently.

Say you're 30 years old, and you cash out a 401(k) account with $20,000 in it. To you, it's a little windfall, enough to buy a new car or maybe pay down some debt. You need to think about what else it could be, though.

If you plan to retire at age 65, leaving that money alone would give it 35 years to grow. If it grew at the market's historic average annual rate of 10%, it would ultimately become about $560,000 -- more than half a million dollars! And that's without adding anything further to the account. If you then withdrew 4% of that money each year in retirement, as has been suggested in our Rule Your Retirement newsletter service, you'd yield $22,400 per year. See what you're throwing away if you cash out now?

Topping $22,400
Lately, of course, it's been tough to find stocks that are able to meet that 10% average. Plenty of stocks, including AIG (NYSE: AIG  ) and Citigroup (NYSE: C  ) , have lost 80% or more of their value in the past year alone.

But over the long haul, good returns are attainable. Check out these average annual returns for some familiar names:

Company

20-Year Average Annual Return

Dell (Nasdaq: DELL  )

28.1%

Altria Group (NYSE: MO  )

15.5%

ExxonMobil (NYSE: XOM  )

13.3%

Procter & Gamble (NYSE: PG  )

13.6%

Johnson & Johnson (NYSE: JNJ  )

13.9%

Source: Yahoo! Finance.

If your $20,000 nest egglet grows at 13%, on average, yearly, in 35 years it will turn into a rather hefty $1.44 million. Just look at that! It's just about enough for most of us to retire on, especially if it's supplemented with Social Security or some other income. Withdrawing 4% of it yearly will give you an annual income of $57,600 to start.

Why so much
If you're wondering how an entire retirement could be based on a 401(k) account that was left alone after the owner turned 30, the answer is compounding -- and the power of time. You could duplicate the results by saving and investing in your 30s or 40s or 50s, but you'd have to save and invest a whole lot more each year. The beauty of early money is that that it has so much time to grow, even if it doesn't seem like a princely sum.

Remember: A dollar today can do much more for you than a dollar five or 10 years from now can do.

Other considerations
Here's a simple, additional reason to leave your account alone: early withdrawal penalty fees. Why fork over 10% of that bundle when you can just leave it to grow -- especially since you'll be paying taxes on the sum upon withdrawal?

Also, don't think that you're limited by just the funds available in your 401(k). If you're leaving your employer, you can roll all your money into an IRA, where you can invest in all kinds of funds, individual stocks, and even bonds.

Take advantage of your savings
Learn more about retirement investing with these great resources:

And for detailed guidance on retirement planning, you can test-drive our Rule Your Retirement newsletter service for free. A free trial will give you full access to all past issues. It regularly offers recommendations of promising stocks and mutual funds.

Frustrated with your 401(k)? Even if your employer's plan isn't the greatest, you don't have to give up your dreams of a happy retirement. Get the tips you need to turn your retirement savings around in our special report, "How To Make The Most of Your 401(k)" -- just click here for instant free access.

This article was originally published on July 30, 2008. It has been updated by Dan Caplinger, who doesn't own shares of the companies mentioned. Johnson & Johnson and Procter & Gamble are Motley Fool Income Investor picks. Dell is a Motley Fool Inside Value selection. The Fool owns shares of Procter & Gamble. Try our investing newsletters free for 30 days. The Motley Fool is Fools writing for Fools.

Read/Post Comments (1) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 30, 2009, at 5:06 PM, Jerry20000 wrote:

    Talk about one sided. First lets talk about Fidelity since this must be the leader of 401/403 fund mangers. In the last 10 years Fidelity has been off shoring massive amounts of its workforce. Simply put your money is not in America. Next all stock are down 50%. If you took you earnings out like all the hedge funds did 8 months ago the penalties and taxes paid you would still be ahead 20% and have that money to invest. Next what about just a savings account or gold. If you are lucky your fund list has a gold fund paper for paper. If you feel you ready to wait out the market where do you put your money. Last diversify. In the last ten years your investments were victims of every markets shorting with no mutual fund manager helping your funds. The saving account of our fathers was land gold and guns. Farmland, gold and guns all have doubled in value in the last 10 years and are a true hedge against depression. Next time you talk about compound interest take a look at your home mortgage and pay it off so you can live debt free, then your earns will have value.

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Selena Maranjian
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Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter...

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