Don’t Cash Your 401(K) When You Leave Work

When you leave a company—whether on your terms or not—you may panic about what happens to your employer-sponsored retirement account. While you have several options for handling the old 401(k) error, some strategies are better than others.

A recent Harvard Business Review study found that of 162,360 employees who quit their jobs between 2014 and 2016, 41.4% cashed out their 401(k) savings when they left. Unfortunately for these employees, cashing out is rarely the right move and can even undermine your retirement security.

Here’s why you should never cash your 401(k) if you can help, and what you should do instead.

Why You Shouldn’t Cash Out Your 401(k)

It’s understandable why you instinctively want to withdraw cash from your employer-sponsored retirement plan. Perhaps you are nervous about the market , worried about cash reserves without your previous job, or confused about the rollover process in general. However, the consequences of early abandonment likely outweigh the benefits. Experts usually advise against cashing it out for the following reasons.

Taxes, taxes, taxes

Aside from employer compliance, the main benefit of a 401(k) is that your savings have tax advantages. On early exit (i.e. before you turn 59.5 years old), the IRS usually requires an automatic withholding of 20%. Let’s say you withdraw $10,000 from your 401(k) account before you reach retirement age. Right now, you can only get about $8,000 in withdrawals (at least before taxes are refunded).

Additional penalty tax

On top of that 20% early withdrawal withholding, you will face a 10% tax as an early allocation penalty from the IRS. This means that $1,000 is added to this hypothetical $10,000 withdrawal, bringing your income down to $7,000.

Blocked Losses

You may be tempted to withdraw your money when the market is down, but you better keep the big picture in mind . And that overall picture probably includes a market recovery and many more years of growth. Don’t sabotage yourself by taking your losses during a down market.

Instead, renew your 401(k) form

Instead, you should merge your old 401(k) into another qualified retirement plan. The obvious benefit is the maximization of your savings, access to a wider range of investments, and the ease of keeping track of fewer funds. Here’s our guide to finding your old 401(k) savings from previous jobs so you can maximize your retirement savings.

If you don’t have the option to convert your old 401(k) form to a new one, it’s best to let it grow before you decide to cash it early.

For large retirement savings, the silver lining of record inflation is a record increase in the cap for your 401(k) in 2023 . And for new retirees, here’s our beginner’s guide to starting a 401(k) .