We have made TONS of financial mistakes over the years; so many, in fact, that when we reflect upon our past, it is a miracle that we are free from consumer debt and continue to pay additional principal on our mortgage every month.
Over the next several months we will be sharing our biggest mistakes. We aren’t doing this because we want to beat ourselves up and relive the decisions we wish we could take back, but because we sincerely hope we can help someone else from making the same mistakes.
Neither of us was raised in a family where financial matters were discussed, let alone healthy financial attitudes and strategies encouraged. This is not to lay blame, but to set the stage that we have, for the most part, been figuring this out on our own. In most cases, we failed to seek — and when we did seek, we often did not find — wise counsel. We find ourselves reflecting on our past and say, what if? It is not helpful, but when we think about retirement, which is creeping up much faster than we would like to admit, it sometimes can’t be avoided.
If you’ve not already “been there and done that” allow us to present our own experiences as cautionary tales.
Not quite 15 years ago, Mr. Frugal Source decided to leave his employer of almost nine years. As is typically the case with such large decisions, it was accompanied by other choices not contemplated as part of the main decision. Primary among these was “what to do with that 401k?”.
Some of you probably know where this is going by now, but for the benefit of those who’ve not been faced with this choice, let’s talk briefly about options. When you leave a job, you have the opportunity to touch your 401k. You can, of course, choose to let it sit right where it is; sometimes you’re even allowed to continue managing it, even though you’re no longer making contributions. If you do this, watch for new fees or reduced or eliminated investment options due to your no longer being a member of that larger investment group. These can reduce your flexibility or start chipping away at your savings since you are no longer a member of the large investing group. There’s often a grace period, so you have a bit of time to make your decision and get things set up.
Another option people have is to rollover your 401k. If you’re not familiar, in a nutshell, a rollover is taking your money with you (as opposed to letting it sit, as above) and maintaining its tax-advantaged status. Sometimes you can rollover directly into your new employer’s 401k plan, and you always have the option of putting it in a new or existing IRA. One of these options is almost always better than leaving your money in the old employer’s 401k. Due to greater control and availability of options, moving that money to an IRA is often considered the best move.
Regardless which of the above options you choose, they are all far better than what I decided to do. Yep, you guessed it, I cashed out. “Can I actually do that?”, you ask? Yes, you can, but if you do, you’re as stupid as I was. And, yes, I’m writing in the first person because this is all on me, Mr. Frugal Source; I can’t bear to let my lovely bride share any of the blame in this whopper — don’t worry, we’ll pull her in for other episodes of “Don’t be like us” ;).
Before we get into why it seemed like a good idea at the time, let’s talk about what happens when you cash out your 401k. After making the necessary arrangements, the account custodian prepares to send you a check. The first thing that happens is that taxes are withheld and, if you’ve not yet reached 59.5 years of age, you pay an additional 10% penalty (to be clear, that’s 10% of the full balance of the account you’re cashing out). By the time you get that check, it has already shrunk quite a bit.
Also, congratulations, you’ve likely just made your taxes that much more complex and, possibly, increased your effective tax rate to boot. That’s right, while taxes are withheld and you pay a penalty of 10%, the full amount of that 401k is considered taxable income for the year you cashed out. Depending on your annual income and the size of your accumulated savings, you could be in for a massive shock when tax time rolls around again. I can tell you, it ain’t pretty.
So, without further ado (i.e. I’ve run out of tactics to delay any further; it’s still stings to deal with, even after all these years), why did we do it? It’s simple, really. I had wanted land of my own to hunt on and for my still-growing family to move to for as long as I could remember. Had I saved up for that purpose? A bit. Was I in debt? Is the sky blue? We had a mortgage and some Credit Card and medical debt at the time. With this choice in front of me, I saw a stack of money I had saved. I saw an opportunity to get what I wanted. To be frank, I found a shortcut. But it was a very bad one.
We had our plan, and we started to execute to the best of our ability. At the time, we had four small children, the youngest of whom was still an infant. This made getting out to see land difficult, at best. I would scour the internet for possibilities, go check out those that sounded promising alone, then find a way to take Mrs. Frugal Source (and sometimes the kids) to see these parcels. As you might imagine, this didn’t bear fruit quickly. Not long after this started, my angel was diagnosed with chronic illness and, as one might expect, interest in land waned quickly. It’s funny how the glitter of the things you want can fade so quickly when the spotlight shines on what is truly important.
So. What happened to “all that money”? Well, we still have a good portion of it; at least we didn’t just let it fall through our hands, but we did squander an opportunity by losing out on all the growth that money might have had. It’s also likely that I pushed out my potential retirement date by a significant amount. We do, however, need to note some silver linings. As mentioned, Mrs. Frugal Source was diagnosed with chronic illness about that time. Having that money available (i.e. not tied up in an IRA) did allow us to visit specialists in far-flung corners of the country without incurring much additional debt. Also, as I mentioned, we still have a good chunk of that money; part of it is equity in our current home, and was a ready-made foundation for our emergency fund once we woke up and started being intentional with our money.
Still, if I had it to do over, knowing what I know now, I would have simply rolled over my 401k, kept adding to my sinking fund for land, and prayed for patience and providence. I would advise that any of you facing a similar decision who are tempted to cash out your money use every ounce of willpower to deny that impulse because, even though it’s yours, it’s not yours. It belongs to future you, and that you needs all the help he or she can get.
I do, however, consider a few circumstances worth considering the now unthinkable, such as risk of losing your home with nowhere else to go, and other such dire circumstances. While I certainly couldn’t condemn anyone for making this choice under conditions of limited hope, I would caution you not to act hastily if you do find yourself in such a situation. Be sure to get good counsel. Talk to friends, family, a financial advisor; anybody who, simply by not being directly wrapped up in the bad situation, may have better clarity to see a path out for you that doesn’t involve risking your financial future.
As always, we’d like to hear from you. According to Fidelity, “1 in 3 investors has cashed out of their 401(k) before reaching age 59½, often when changing jobs”, so we know we’re not the only ones. Are you, like us, part of that 1/3? If so, why did you do it? Would you do it again? What did you learn? Anything you can share that might help others who might be weighing such a decision, whether now, or in the future,