Why You Should Avoid Cashing Out Your 401(K)

Posted on Dec 01, 2016 By Grant McNutt

Attorney Grant McNuttMany of my clients come to me six months after cashing out their 401(k).  At the time, it seemed to be a good idea to solve a short-term cash crunch.  Unfortunately, cashing in a 401(k) can cause problems in the future.  It is often easy to cash in your 401(k) as long as you can prove you are having a hardship, such as temporary cash-flow problems created by the loss of a job or an emergency home repair.  Sometimes I hear they have simply paid down a credit card or caught up a loan, with no ability to pay the very next month.  In essence, they have put a band aid on their financial situation that often times awakens only a few months later.  Also, in the panic of cashing in the 401(k), it probably came as a surprise that 20% or more is paid in taxes plus another 10% in early pay out penalties.  So the $3,000.00 they thought they were getting ended up barely $2,000.00.  If you have dipped into or cashed out your 401(k), you are not alone.  Studies show 1 in 3 make the same mistake doing so before they turn the required 59 ½.

Consequences of Cashing Out Your 401k

There are also long-term consequences.  What might seem like a small amount now, can be a significant nest egg at retirement, after 25 to 35 years of compounding interest and growth.  The power of tax-advantaged accounts, which includes 401(k)’s is that they allow for pretax contributions to compound without taxes eroding that growth.  Over time, earnings can generate their own earnings, helping you accumulate more money than you would in an ordinary taxable account.   A couple of my favorite quotes, both by Albert Einstein, deal with compound interest.  Einstein stated, “Compound interest is the eighth wonder of the world.  He who understands it, earns it…he who doesn’t…pays it,” and “Compound interest is the greatest mathematical discovery of all time.”  The moral is don’t touch your 401(k) and let it work for you.

Cashing Out When Changing Jobs

Another myth I hear from my clients is “I had to cash out my 401(k) when I changed jobs.”  That simply is not true.  Please go to your bank or any financial adviser for help rolling it over into an IRA which will keep its tax-advantage status.

Another compelling reason to leave your 401(k) alone is security.  Your creditors simply can not touch your 401(k).  It is 100% exempt in Bankruptcy.  It’s an entirely different story once you cash it out and it hits your bank account.  Your creditors can place a garnishment on your bank account if they have first sued and obtained a judgment against you.

If you are struggling to pay credit cards, medical bills or personal loans, not to mention your mortgage and vehicle loans and are contemplating invading your 401(k), please call one of our conveniently located offices at Bond & Botes first and set up a private consultation with one of our experienced attorneys.

We will analyze your situation and help you make the best decision possible to help you navigate your financial problems.