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Spend Now, Pay Later, Planners Caution

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Financial advisors assail the ‘spend now, pay later’ habits of workers who take cash rather than roll over 401(k) money when they change jobs, according to interviews.

Choosing to spend money meant for retirement can have a devastating impact on a worker’s income planning for retirement, they caution.

Their remarks came in response to a finding that 45% of those leaving their jobs elected a cash distribution rather than a rollover. The finding appears in a survey, conducted by Hewitt, Lincolnshire, Ill., and released in July 2005, that polled nearly 200,000 workers who participate in their 401(k) plans.

Mary Schapiro, vice chair of the National Association of Securities Dealers, Washington, noted the finding in a March 20, 2006 speech before a Securities Industry Association conference. In the speech, Schapiro said, “This is a trend that we are worried will increase as people begin to exhaust their home equity lines of credit.”

Currently, the majority of cash-outs are done by younger workers who do not have a lot of money in their 401(k)s, according to the Hewitt survey. Sixty-six percent of cash distributions, Hewitt found, are in the 20-29 age group.

Also, 72.5% of workers with 401(k) balances under $10,000 took cash distributions, Hewitt says. The number of workers taking distributions drops to 31% when the 401(k) plan balance was between $10,000 and $20,000 at termination, Hewitt says.

Planners say that even if the balance is small, the impact is large.

Workers in their 30s don’t think the balance in their accounts is a lot of money, but even if it is $10,000, with compounding, it adds up, says Jeffrey Golden, a certified financial planner with Circle Advisers, New York. If a worker in his or her 30s works through 65, and earns 7% annually, money would double approximately every 10 years, he says. So, in the time between the job change and retirement, that worker would have forfeited approximately $80,000, he estimates.

“The intention for the money is to squirrel it away for retirement. Why would changing jobs change that intention?” Golden asks.

The issue does not come up a lot in his practice, he says, since most clients roll over their money into either an IRA or the new company’s plan. Golden says this is where an advisor can serve as an alter ego, guiding the worker in a rollover decision.

Even someone in the 20s will be losing a lot of compounding, concurs Michael Garry, a certified financial planner with Yardley Wealth Management, Newtown, Pa. “Time slips away and then you are in your 30s with a family and a mortgage,” he notes. So, “it is bad no matter how small an account,” he says.

“It is frightening to think that you are losing a third to 40% of your 401(k) to taxes,” Garry says. If a highly paid worker decides to take a distribution, then the marginal rate paid could be higher than in retirement, he adds. “It would be hard to know what would be a better use of that money now, unless it was a dire situation.”

While the cash-outs are probably from workers who have been at an employer only a short time and who therefore have only a small amount in their accounts, John Ritter, a certified financial planner with Ritter Daniher Financial Advisory, Cincinnati, Ohio, says, “Any time there is a chance for a tax-deferred dollar, I hate to see it wasted.”

Between 35% and 40% of that money is “walking away between the penalty and income tax paid,” he continues. Even those without an advisor can roll it into a no-load fund family, Ritter adds.

As a general rule, it is not an issue that comes up with clients, according to Doug Taylor, a certified financial planner with Taylor Wealth Management, Torrance, Calif. In rollover situations, he says he generally recommends that the people roll the funds into an IRA, because this offers more flexibility in investment choices. However, if the client is in a profession that is vulnerable to liability suits, Taylor adds, he would recommend keeping the money in a 401(k) because of the plan’s ERISA protections against creditors.

Above all, Taylor says that he would not recommend cashing in the money, because “they would never recover from the tax hit if there is an early distribution.”

Kevin Brosious, a certified financial planner with Wealth Management, Allentown, Pa., says the matter hasn’t come up with clients, but if it did he would recommend against it. Those who are taking cash instead of rolling over assets probably do not have advisors, he conjectures. With the possibility of a tax bill as high as 40%, “they are eating their seed corn” today at the expense of tomorrow, he says.


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