Changing jobs? This 401(k) mistake could cost you big — read before you cash out

The US is already halfway through the 2020s, but its 401(k) retirement system still works like it did many years ago. Earlier, people usually worked one job their whole life and got a fixed pension after retirement. Today, things are very different because people change jobs often. The average American worker now has about 12 jobs in their lifetime. Most job changes happen before the age of 40, as per U.S. Bureau of Labor Statistics.

Every year, around 15 to 20 million workers switch jobs and deal with new retirement plans, as stated by Kiplinger. People also move houses a lot, which adds more confusion. On average, Americans change homes about 11 times in life. Around 15 to 25 million retirement account holders change addresses every year.

Every year, about 4 to 6 million Americans retire. Around 60% to 70% of these retirees have some kind of retirement savings plan. Because of job changes, moving homes, and retirement, people end up with many different retirement accounts.

System problem

The retirement system is not well connected because different companies use different technologies. These systems often do not “talk” to each other properly. The system includes millions of savers and many service providers, making it complex. Because of this complexity, people find it easier to just leave their old 401(k) accounts behind, as per Kiplinger report.

Moving money from one plan to another is slow and confusing. Old technology systems make the process even more error-prone. Even when companies upgrade systems, they still must deal with outdated systems from others. This creates “friction,” meaning unnecessary difficulty in managing retirement savings.

Inactive & “lost” accounts

Many people leave money in old employer accounts after changing jobs. The share of inactive retirement accounts has grown from 21.1% in 2010 to 29.2% in 2023, as noted by Kiplinger. This means nearly one-third of accounts are inactive. But inactive does NOT always mean forgotten. Some people keep old accounts because fees are low or investments are good. So calling all inactive accounts “lost” is misleading.

Real signal of problem

A better sign of a lost account is when mail is returned because the address is wrong. Returned mail shows communication has broken down, as per Boston Research Technologies & Retirement Clearinghouse via Kiplinger. Even then, it doesn’t always mean the person forgot the account.

Small account rules & risks

Accounts under $1,000 can be automatically cashed out. Accounts under $7,000 can be moved to safe accounts if no action is taken, as cited by Kiplinger. These rules were made to simplify things for companies. But they can create problems for workers later. If contact details are wrong, people may not even know their money was moved.

Loss from cashing out

Even small withdrawals can hurt future savings badly. A 25-year-old cashing out $750 today could lose $9,312 by retirement. This assumes the money could have grown at 6.5% annually.

Cash-out problem

Many workers cash out their 401(k) when they change jobs. This happens because transferring money is difficult. Cashing out leads to taxes and penalties. It also reduces long-term retirement savings.

Big impact of not cashing out

Keeping $7,000 invested from age 25 can grow to $86,912 by age 65. Keeping three such accounts can grow to $157,878, as noted by Kiplinger.

Who cashes out more?

At least 33% of people withdraw money after changing jobs. Young workers (20–29) cash out at a higher rate of 44%. People earning $20,000–$30,000 cash out at a rate of 50%. Hispanic workers cash out at 57%. Black workers cash out at 63%, as per Kiplinger.

Solutions being built

The industry is now trying to fix these problems with better digital systems. New systems aim to make transferring money faster and easier. One key solution is “auto portability”. This automatically moves small balances to a new employer’s plan. It works unless the worker chooses to opt out. The goal is to stop people from cashing out or forgetting accounts.

A system called Portability Services Network has been launched. It helps companies move retirement money smoothly.

What workers should do

Workers should ask how their retirement money will be handled when they change jobs. They should also check options to combine multiple accounts. This helps avoid unnecessary cash-outs.

The real issue is not that people forget their money. The real problem is that the system makes it too hard to manage and move that money. Fixing the system and making transfers easier is more important than worrying about “lost accounts”, according to the Kiplinger report.

FAQs

Q1. Why do people lose track of their 401(k) accounts?
People lose track because they change jobs and homes often, and the system is not well connected.

Q2. Is it bad to cash out a 401(k) after changing jobs?
Yes, cashing out early can reduce future savings and also lead to taxes and penalties.