As many readers know, this past summer I quit my job to be a stay-at-home mom and blogger. This has led to a variety of changes in our life here at Casa Frugal, and I was reminded of yet another factor that we need to consider when I recently received a letter in the mail from my former employer’s retirement plan.
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Basically, the letter starts out something like this:
Hey Dee, we heard that you no longer work here [duh!] You need to consider what you are going to do with your retirement money. Here are your options. 1) Cash out, 2) Keep your money in your former employer’s retirement plan, or 3) Roll your retirement savings into an IRA.
Cash Out My 401(k)??
When I received this letter in the mail, I stared at it for a few minutes and then started laughing. Cash out? Are they serious???!? I could not believe that was even listed as an option, much less the FIRST option.
In all fairness, they DID have the decency to make it apparent to me that I stand to lose a great deal of money if I were to choose to cash out. The vested account balance on the day that this letter was sent to me was $57,958.89.
Should I choose to take a cash withdrawal, the letter indicates that the money will be subject to a mandatory 20% federal tax withholding (plus extra if our tax rate exceeds 20%) plus state tax and early withdrawal penalty. In total, the fact sheet mailed to me indicates that I would stand to lose $20,286 if I were to take a cash withdrawal, which would leave me with $37,673 to keep.
Pretty scary stuff. The penalties are STEEP for early withdrawal. And yet I cannot help but wonder how many others receive this same letter and make the choice to cash out. After all, I do think it would be pretty cool to have an extra 37 Gs in our bank account right about now. We had a pretty expensive summer, what with our adoption and our crazy problems with hail damage and basement flooding this past spring.
However, I absolutely do NOT think it would be a good idea to cash out my 401(k)!!!! Talk about the worst idea ever. Which is why I was pretty appalled when it was the first option on the list!
Despite the fact that they listed cashing out as an option, I was actually pretty impressed with the next part of the letter from my former employer’s retirement plan. They indicate, in writing and graphically, exactly how much this money could be worth to me in 10, 20, or 30 years (assuming a hypothetical 7% rate of return). Here it is.
As you can see, this $57K could be worth considerably more to me in the future! I could really use that money someday. That money could be used for food, housing, or medical costs in the future, at a time when I will be older and may have less ability to earn an income.
Really, it comes down to this: Would I rather have $37K now or $441K in 30 years? Easy. No contest. I want to harness the extraordinary power of compound interest and have $441K in 30 years.
Does it Make Sense to Tap Your Retirement Nest Egg?
However, this letter and this whole situation left me wondering something: Are there any circumstances under which I might consider cashing out my 401(k)??
I found that in order to answer this question, I first had to think about which circumstances under which I would NOT cash out my 401(k).
I would NOT cash out my 401(k):
- To pay off consumer debt. Unless maybe my family was at risk of being homeless if we could not make our mortgage payment. And even then, if we were not able to make our mortgage payment, to me that is a good indication that maybe we should not be homeowners.
- To buy a home. Same reasoning here! If we cannot afford a down payment without reaching into retirement accounts, then we do not need to be buying a home.
- To buy an automobile. NEVER!! We’d walk or bike or take public transportation. We would not in a million years touch a retirement account to buy a vehicle.
- To start a business. Don’t something like 80% of small businesses fail within ten years? If a small business fails, we are going to need our retirement accounts more than ever!
- To send our child to college. No. We would not. We love her dearly, but I think that the best thing that we could do for our daughter is to make sure that our needs will be taken care of in retirement so that we will not ever become a financial burden to her. It’s like they say on the airplane: You have to take care of yourself before you can take care of anyone else.
So what does that leave?
After careful consideration, I think that the only times I might seriously ever consider cashing out or tapping into a retirement account would be if:
- If I owed money to a family member and it was damaging the relationship (which is why I never borrow from or loan money to family members in the first place… so the odds of this scenario happening are nil anyway)
- To pay for life-saving medical treatment for a family member, if for whatever reason insurance would not cover it (I don’t really see this one happening either, but I don’t trust my insurance company any farther than I could throw them, so this one is going on the list).
In other words, it would take a pretty extraordinary circumstance to make me tap into a 401(k). That money is for our future and nothing else! By the way, my favorite online resource to help manage/budget your money and plan for retirement is Personal Capital (review here). Signing up for a Personal Capital account has really helped us get a better handle on our finances in general, but retirement savings in particular thanks to neat tools like Personal Capital’s 401(k) fee analyzer. And best of all, it’s absolutely FREE.
What do you think? Are there any circumstances under which you would or would not cash out or tap into a 401(k)?
Suggested Reading: I think a good comprehensive guide to retirement planning can be found in The Bogleheads’ Guide to Retirement Planning, if you are interested in reading more on this important topic.
P.S. If you liked this post, you might enjoy using our free Net Worth Calculation Template. Sign up now to receive each new post delivered to your inbox, and we will email you the template! Sign up here.
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