Why you should keep your money in your 401k plan
Photo by: nbreazeale
We had some friends over for dinner the other night. We try to get together with them about once a month. Pretty much every time they come over, Mike either asks me questions about his 401k or brings over some 401k paper work he needs some help with. Mike is a really hard worker who builds patios and decks for a national outdoor room company. He knows a tremendous amount about building houses, rooms, patios, decks, and fixing cars but he knows little to nothing about finances or investing. Mike, his wife and their three girls have been friends of ours for a long time, and I don’t mind helping him out at all.
Over dinner, he told me about a co-worker of his that recently pulled out all of his 401k plan money, and the co-worker was advising Mike to do the same. I asked him why the co-worker was pulling his money out, and Mike explained that his co-worker had noticed that over the past few months he was losing money. To keep from losing money, he pulled it out of the 401k plan and placed it into a savings account. He asked what I thought. My immediate reply was “No!” and I explained to him why this was such a bad idea:
A 401k plan is a long term investment
Most 401k plans offer mutual funds as the primary investment tools. Mutual funds are a long term investment, and most financial experts recommend keeping your money in them for more than 10 years at the minimum. Mutual funds consist of company stocks, and based on the market the values of the fund over any one period will be high and low depending on how the market is doing. Right now, the market is down, and thus most everyone’s investments, mutual funds, and 401ks are taking a beating. I know mine is.
The good news is that over the history of the market, stocks and thus mutual funds return on average 10-15%. In order to receive the benefits you have to hang in there and keep putting your money in even when the market is down.
Another point is as you contribute money, you are buying new funds. When the market is down, you are buying those funds at a lower price and when the market does go back up you will earn more. Remember: buy low, sell high.
There’s a penalty for pulling out your money
When you take an early withdrawal of your 401k money, there is a mandatory IRS early withdrawal penalty of 10%. Additionally, your 401k money will be treated as taxable income. 20% will automatically be pulled out, and the remainder will is required to be listed as income when you file your federal and state income taxes. Depending on the amount in your 401k, this can be a considerable some of money and can cause you to have to pay a larger than expected amount of income tax.
Chances are you’ll spend the money
As with any large windfall of cash, most people want to spend either some or all of it. While his friend said he moved it into a savings account, I don’t believe that he truly moved it all, nor do I believe it will stay there. I know from past experience when I received a large windfall of money, we spent some portion of it on things we wanted. Examples include a new truck, camper, wide screen HDTV, computers, etc.
Leaving money on the table
Mike’s company contributes 50% for every dollar he contributes up to 6%. I explained to Mike that this is “free” money and promises far greater returns than any savings account could offer. My employer contributes dollar for dollar, so my free money is even more. Just because your investments are doing poorly right now in your 401k plan, don’t forget the employer match if you have one. Over time, this can cause considerable growth for your retirement fund.
In the end
Fortunately, Mike took my advice and is both keeping his money in his 401k plan and continuing to fund it. I was really glad he made this decision and it will pay off for him in the long run. He was anxious to talk to his friend and tell him how crazy he had been for pulling his money out. While I feel bad his friend made such a bad decision, I do home he learns from the experience.
Keeping your retirement money in a 401k plan provides proven returns, reduced income taxes, and incentive via penalties and tax hits to keep your money in it and not use it unwisely. Contributing to a 401k and/or IRA program can change your financial life and quickly start your path towards being wealthy. If you aren’t contributing to a 401k or IRA program, start today.
I am not an investment guru by any means, but would highly recommend you read The Dough Roller and Moolanomy whose blogs focus more on investing and retirement. Oh, and while I’m thinking about it, if you do have a 401k, don’t take out 401k loans. I wrote about why taking out 401k loans is a bad idea a while back.
Did I miss anything? Can you think of other reasons pulling your money out of your 401k is such a bad idea? Add a comment!
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