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Cash-outs damaging bottom line of 401(k)

– Workers’ 401(k) balances have never been bigger, thanks to continued contributions and a surging stock market. But many savers continue to make a mistake that’s costing them thousands of dollars, if not more.

When workers leave their jobs, they have the choice of leaving their 401(k) accounts alone, rolling them over into another tax-deferred retirement account or cashing them out and pocketing the money. Last year, 35 percent of all participants who left their jobs cashed out their accounts, according to the nation’s largest 401(k) provider, Fidelity Investments. That’s up from 32 percent in 2009.

The move provides some quick cash, but it’s also likely the accountholder will have to pay penalties: Nearly everyone younger than 59 1/2 must pay 10 percent of the account balance as a penalty. Add on top of that the income taxes that come due, and the price tag quickly escalates.

The average balance of a 401(k) account that was cashed out last year was close to $16,000, Fidelity says. Of that, the typical person pocketed just $11,200 assuming 20 percent was withheld for taxes and the 10 percent penalty was assessed. But that’s not the worst of it, says Jeanne Thompson, vice president at Fidelity Investments. It’s the lost opportunity for the saver, who no longer gets the compounded growth the savings would have had in a retirement account.

Cash-outs are most prevalent among younger workers, the ones who would most benefit from keeping the money in a tax-deferred retirement account. They have the most years of possible compounded growth ahead of them before retirement.

“Many young people are struggling: They’re paying off debt or trying to buy their first car or first home,” Thompson says. But if they had kept the $16,000 invested, Fidelity says it could have grown big enough to provide nearly $500 per month in income during retirement.

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