Tapping retirement funds is a terrible idea

By the numbers, 2021 was a rousing year for resignations. A record percentage of Americans decided that it was time to find a better job, start their own business, or simply take a break for self care.

I get that.

Here's the problem: One in 3 workers cash out their retirement accounts when leaving jobs, according to research provided by the Women’s Institute for Secure Retirement (WISER). For workers between the ages of 20 and 30, that jumps to 41% or higher, said Cindy Hounsell, president, and founder of WISER.

“It's the job-changing that provides the opportunity to take out the money,” she said.


I get that, too.

That’s exactly what I did when I was 29 and leaving my employer. I cashed out my 401(k) plan’s balance to pay off some credit card bills. It wasn’t a lot of money, roughly $5,000. I felt I didn’t have a choice, and retirement was decades away.

If I had not done that, the modest sum — conservatively invested combined with the power of compounding — would be worth more than $70,000 today.

Overall, nearly 1 in 5 Americans with retirement accounts have taken an early withdrawal from a retirement account since the start of the pandemic, according to a Bankrate survey. And younger workers led the way. Four in 10 Generation Z workers, those under 25, took a withdrawal beginning in March 2020, per Bankrate’s findings, compared with 19% of millennials, those 26 to 41, and 12% of Gen X workers 42 to 57.

Female arm hold bunch of credit cards picking one closeup. Convenient set of funds, budget wallet deposit, wealth and effective investment, invest resources, income profit concept
My biggest financial mistake was cashing out my 401 (k) account to pay off credit card debt when I was 29. (Photo credit: Getty Creative) (Ivan-balvan via Getty Images)

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Leaving jobs, of course, is just one motive for tapping retirement accounts, but it is, without question, a notable one these days.

“I find it bizarre that people are doing so much of this,” Hounsell said. “Do they even understand what the rules are?”

Pulling money out of a tax-deferred retirement fund before you’re 59 ½ is rarely a good idea. The IRS levies a 10% penalty on distributions taken before the account holder is 59 ½. And income taxes are due on the funds that are withdrawn.

Hounsell’s advice: “Run the Retirement Clearinghouse’s Cash Out Calculator to show you what even a small balance cashed out can cost you,” she said. “Maybe you don't hate your job so much.”

Consider the opportunity cost

Michelle Connell, owner of Dallas-Fort Worth-based Portia Capital Management, agreed.

“If you’re thinking about leaving work and cashing out your retirement account, you better think about the opportunity cost,” Connell said.

“In fact, younger workers should be putting more in, not taking it out,” she said. “Everybody’s looking at their accounts and saying, ‘wow, my retirement account has really gone up. I'm going to retire early and start using this money.’ Do you really know the cost of what retirement is going to be? Do you really know how long you're going to live?”

Easier said than done. It’s just so tempting. All these years later, I still consider cashing out my 401(k) plan to be the financial mistake I regret the most.

Retirement plan leakages come from several key sources. The leading cause is job separations, followed by to a lesser extent home purchases, divorces, large medical expenses, and new college tuition bills, according to an analysis published in the National Tax Journal.

That cash-out finding brings me back to The Great Resignation and siphoning retirement savings. This is not a new phenomenon. It’s simply one that accelerated during the pandemic as droves of workers hit the exit ramp.

People captured in mid air, while jumping on trampoline in big studio.
The younger you are, the higher the chance that you’ll be jumping ship. (Photo credot: Getty Creative) (Klaus Vedfelt via Getty Images)

Jumping jobs can be a trigger for dipping into accounts

These are inflection points. And, pandemic aside, they actually come along pretty frequently for most of us. For more than three decades, the median tenure of all wage and salary workers ages 25 or older has been around five years, according to The Employee Benefit Research Institute (EBRI).

And the younger you are, the higher the chance that you’ll be jumping ship. In 2020, the Department of Labor reported a 10-year median job tenure for workers between the ages of 55 and 64 compared with just under three years for workers between ages 25 and 34.

For women, this cash-out reflex is particularly worrisome. Every little bit saved and invested counts for future financial security.

“Women’s longevity means that they will likely need more income in retirement than men,” Hounsell said. “One out of two women in their mid-50s today will live until age 90. And women are more likely to be single and at much greater risk of poverty as they age than are men.”

Confused about your options? Talk to your former plan’s administrator or HR officer. I wish I had.

If I had any sense of what my tiny cashed-out 401(k) could have ballooned to by the time I reached retirement, I’m pretty sure I would have unearthed another way to find funds to pay off those credit cards.

Kerry is a Senior Columnist and Senior Reporter at Yahoo Money. Follow her on Twitter @kerryhannon

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