Published July 14, 2005

In 1979, after 12 years of training and education in the financial services industry, I hung out my shingle to begin my private practice of financial planning.

There were a few challenges. Most of them revolved around the lack of money. I had a mortgage and a growing family. I need ed to open an office, buy some furniture, get the phones connected, etc. It was tough getting started.In order to survive, I did what many Americans do. I cashed out my profit sharing plan from the firm who gave me all the training and experience. It was $27,500. It seemed like a lot at the time, but it barely got me through the first year. What if I hadn’t cashed it out? What if I had left it invested? Let’s say I invested it equally between the S & P 500, the Dow Industrial Average and the NASDAQ Composite.
Where would I be today?
An equal weighting of those indexes would have provided me with a 10.58% annual return from the beginning of 1979 to the beginning of 2005. My little nest egg would be worth $376,066 today. If I let it ride another 6 years until I were age 65, it would grow to $687,580.

According to Hewitt Associates, a large retirement consulting firm, nearly 42 per cent of American workers cash out all of their 401k or profit sharing plans when they change jobs. Is this surprising? Not to me.

There are a many reasons to cash out. Some say the amount is so small “why leave it.” Many will say that retirement is too far off to worry about. Others need the money to transition to a new job. Some use it to pay off debt. Many use the money to buy something like a car, a boat or vacation.

Whatever the reason, for most people it is a huge mistake.
Let’s explore the impact of this mistake. Assuming you work five years at each of the five jobs between the ages of 25 and 50. Assume that at each job your 401k/profit sharing account accumulates to $5000 at the end of each five years. Also, let’s assume that you invested the money at an 8% annual rate of return.

If you would have kept the money invested instead of spending it, your retirement account would be worth $197,645 at age 50. If you left it invested until you retired at age 65, your account would be worth $626,963.

Of course, this money would be fully taxable when it is withdrawn, but who’s kidding whom? Isn’t six hundred grand “fully taxable” still an impressive amount of money?
I know, there may have been plenty of good reasons to take the $25,000 out. Keep in mind that, in today’s tax environment, the $5,000 withdrawn at each job change would be subject to regular income tax plus a 10% tax penalty. Assuming a 30% combined federal and state income tax bracket plus the 10% early withdrawal penalty, you would net only about $3,000. You may thinking this is one of those youthful mistakes workers make.
Again, according to Hewitt and Associates, fully 33% of workers in the 50 to 59 year old brackets cash out their 401k’s as well.

What is the lesson here? Don’t let today’s short term needs over take your long term goals. In order to acquire enough assets for a comfortable retirement, it takes discipline. It requires an understanding of “compound investment return.” It requires a little sacrifice. It requires an understanding that it takes time to build wealth.
Am I sorry I didn’t keep my $27,500 invested? Not one bit. If I had bought a boat, or something else, I may have regretted it. I didn’t spend the money. I traded one investment for another.

Notable Quote: Sacrifice: Giving up something good for something better. -Roderick B. Smith.

Tom Mills & Jonathan Gates are partners in Mills, Parker & Gates LLC, a registered investment advisor.
If you have questions or topics, you may write Tom or Jon at 809 Broadway Sonoma CA 95476.
They can be reached by phone at (707) 996-7800, by FAX at (707) 938-8668 or by e-mail at suntrm@aol.com