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Beware of Higher Tax Bill Before Dropping 401(k)

Beware of Higher Tax Bill Before Dropping 401(k)

Associated Press

“Taking all your money and putting in the bank even sounds scary now,” Thaler said. “So freezing in place is the gut reaction people are having.”

The long-term implications aren’t clear. Trade groups and organizations tracking 401(k) trends are keeping a close eye on another trend they find equally disturbing. Specifically, they’re concerned about how many of the nation’s 5 million unemployed workers are handling their retirement savings.

“If you lose your job nobody would blame you for stopping contributions until you find another job,” Thaler said, “but I think people would be ill advised to pull the money out if there’s any way to avoid it.”

When a worker loses a job the 401(k) balance can be rolled over to an individual retirement account, which offers many of the same benefits of an employer sponsored plan.

Cashing out a 401(k), however, before age 59½ is costly. You’ll have to pay a 10% penalty and the taxes due on the money. You basically give up more than a third of your money to the government in most cases.

Hess of Hewitt Associates shares that concern. Statistics show nearly 80% of workers with less than $10,000 in their 401(k) cash out the account when they leave a job rather than roll the money into another retirement account. Those workers could end up with little or no retirement savings if they keep doing that, she said.

“It has long-term implications and should only be done as a last resort,” Hess said.

Suckstorf, the Maryland financial planner, said many workers today have little choice but to continue putting money aside for the future. Most workers don’t have pensions and the Social Security system will likely not provide the level of support for future retirees as it does today since current projections show the fund will begin to fall short in 2017.

“It may sound cliché, but somewhere down the road you’re going to end up being a ward of the family or the government if you don’t do something,” Suckstorf said.

Follow the advice of financial planners and contribute at least at the level of your company’s match if you can. Don’t lose sight of the primary reasons for putting money into your 401(k) account — a comfortable retirement income and the tax benefits you’re getting now.

©2009 Yellowbrix, Inc.


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