Losing a job can constitute a big blow. Not only do you lose a part of your identity, but you also lose your steady paycheck.
Now upon getting terminated from a job, you'll generally clear out your desk and take your personal belongings with you. But what about your 401(k) plan?
You may be tempted to cash out your retirement plan once you're no longer employed by the company sponsoring it. But that could be a huge mistake.
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Cashing out a 401(k) is common
Data from the Employee Benefit Research Institute finds that each year, about 40% of workers who are terminated from their jobs elect to cash out 401(k) plan assets. But cashing out is a problem on multiple levels.
First, if you cash out a 401(k) prior to reaching age 59 1/2, you face a 10% early withdrawal penalty. But that's not the only problem. A perhaps even worse consequence is that you risk facing a financial shortfall once retirement actually rolls around.
Let's say you're terminated from your job at age 35, at which point you have a $10,000 balance in your 401(k). The early withdrawal penalty associated with that distribution is $1,000 -- not a negligible amount of money, but not necessarily an earth-shattering one.
However, what if you're not retiring until age 67 and you're able to invest your retirement savings at an average annual 8% return, which is a bit below the stock market's average? Suddenly, you're looking at a potential shortfall of over $172,000 when you account for 37 years of lost growth on your $10,000 balance. That's far more problematic than losing $1,000 to an early withdrawal penalty.
Roll that 401(k) into an IRA
Losing a job can be very aggravating. And you may not want to pile onto your aggravation by having to deal with the paperwork necessary to open an IRA and roll your 401(k) into it.
But if you don't take that step, you might end up short on savings once retirement rolls around. So it's a step worth taking, even at a time when you might prefer to wallow in your disappointment by doing nothing but binge-watching TV for days on end.
In fact, if there are rumors of layoffs hitting your company, one thing you may want to do proactively is open an IRA so your account is nice and set up before your job becomes a thing of the past. If you already have an IRA in place, it'll make the process of transferring the funds in your 401(k) much smoother.
Of course, you may have the option to leave your 401(k) funds where they are once you're terminated. That, too, might seem like an easy way out, and at least it doesn't involve you cashing out your account.
But if keep your 401(k) where it is, you run the risk of forgetting about those funds down the line. So really, your best bet is to roll your retirement money into an IRA, where it can continue to grow and you can watch over it with ease
