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The Great Resignation and Early Retirement Account Withdrawals

Over the past couple of years, the United States has experienced an employment phenomenon that’s commonly referred to as the Great Resignation. Millions of employees left the workforce in 2020 and 2021 — some due to the pandemic and some for a variety of other reasons, including generous federal government benefits that sometimes made it more lucrative to stay at home than to work.

In November, 4.5 million employees voluntarily left their jobs, which was an all-time high for one month, according to the Bureau of Labor Statistics. When leaving their jobs, many of these employees have to make a decision about what to do with their employer-sponsored retirement accounts like 401(k)s.

401(k) Cashouts Are Rising

Unfortunately, a high percentage of these employees are cashing out their 401(k)s instead of rolling the money over into a new employer’s 401(k) plan or an IRA. According to the Women’s Institute for Secure Retirement, one out of three employees cash out their account when leaving their job. This rises to 41% of employees between the ages of 20 and 30.

What’s more, about one in five Americans have taken an early withdrawal from a retirement account since the pandemic began, according to Bankrate. Again, younger workers age 25 and under were much more likely to do this (four out of 10) than millennials (two out of 10) or Gen Xers (one out of 10).

Cashing out a 401(k) account or taking early withdrawals before age 59½ usually isn’t a smart long-term financial move. For starters, the IRS will levy a 10% early withdrawal penalty on the money that’s distributed. In addition, the funds will be taxed at ordinary income tax rates. So the amount of money that you actually receive when cashing out the account or taking an early withdrawal will likely be considerably less than the actual account balance.

The Retirement Clearinghouse has created a Cashout Calculator that shows how much cashing out a 401(k) early can cost over the long run. For example, if a 30-year-old cashed out a 401(k) account with $10,000, he would pay $3,000 in taxes and penalties, leaving him with just $7,000 in cash, according to the calculator. But if he left the money alone until he retired, his account would grow to $42,000, assuming a 5% annual rate of return and retirement at age 59½.

Rollover the Funds Instead

Instead of cashing out a 401(k) when leaving a job, it’s usually smarter to roll over the funds to a new employer’s plan or an IRA. If you take a new job at a company that offers a 401(k) plan, talk to the human resources department about how to open a new account there and have the money in your old employer’s 401(k) transferred into it.

The other option is to perform an IRA rollover. First, you will open a new IRA at a financial institution or investment company. Then you will inform your former employer that you want to roll over your account balance into your new IRA via a trustee-to-trustee transfer. This will avoid an automatic 20 percent withholding that applies if the funds are transferred directly to you while also preserving the tax-deferred status of the funds.

Another option might be to leave the money in your former employer’s plan if the plan allows this. The benefit here is that no taxes or penalties will be assessed and you can continue to benefit from tax-deferred compounding to grow your money for retirement.

One potential drawback to this strategy is that the money might end up “out of sight, out of mind.” It can be difficult to keep track of and manage money that’s left behind in multiple previous employers’ 401(k) plans, which can negatively impact long-term investment performance. Also, you won’t be able to make any more contributions to the account and you’ll no longer receive any matching contributions from your former employer.

We can talk to you further about your retirement account options if you have recently left a job. Contact us to schedule an appointment time that’s convenient for you.

 

The commentary is limited to the dissemination of general information pertaining to Frontier Wealth Management, LLC’s (“Frontier”) investment advisory services. This information should not be used or construed as an offer to sell, a solicitation of an offer to buy or a recommendation for any security, market sector or investment strategy. There is no guarantee that the information supplied is accurate or complete. Frontier is not responsible for any errors or omissions, and provides no warranties with regards to the results obtained from the use of the information. Nothing in this document is intended to provide any legal, accounting or tax advice and Frontier does not provide such advice. This information is subject to change without notice and should not be construed as a recommendation or investment advice. You should consult an attorney, accountant or tax professional regarding your specific legal or tax situation.