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Planning to join the Great Resignation? Don’t cash out your 401(k), experts say

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A third of employed people say they plan to look for a new job this year, and many of them are likely to make withdrawals from their 401(k) — a move financial planners almost always advise against.

Thirty-six percent of workers polled last November say they plan to look for a new job in the next 12 months, according to a workhuman survey. The survey includes 2,268 fully employed people in the U.S., U.K., Canada and Ireland as respondents. 

However, many of the U.S. workers who have quit their jobs during the pandemic — a phenomenon known as the Great Resignation — say they've cashed in their savings to make it happen.

Around 21% of Americans who quit their jobs during the pandemic say they cashed out their 401(k), according to a recent Fidelity survey of 2,622 U.S. adults with at least one retirement account.

However, financial planners generally recommend that workers avoid making any early withdrawals from their retirement savings in order to let the money grow for when they actually retire.

"Cashing out of a 401(k) is probably the most tempting — yet often most devastating — action someone can take when they leave their employer," says Scott D. Schwalich, a wealth strategy advisor at Anderson Financial Strategies, LLC.

Early withdrawals before age 59½ typically trigger a 10% penalty. Plus, the withdrawal is taxed as income, which creates a potential 10 to 37% tax burden for the worker, Schwalich says. Even worse: "you can't make up for lost time," he adds. The cost of missing out on years of compound interest can drastically reduce your retirement savings, which could force you to work longer than you originally planned.

"Every client we've ever worked with wants to reach that 'work is optional' stage in life, regardless of how much they love their job," Schwalich says. "For many, cashing out of a 401(k) could cause that day to come too late."

Of course, sometimes people are forced to cash out their retirement savings to cover the cost of unexpected emergencies, like debt from medical bills. In fact, there are reasons for withdrawals that won't trigger the 10% penalty, like having a disability or needing to pay for taxes and health insurance premiums. However, the withdrawal is still taxed as income.

Make sure you have a financial plan before quitting your job

Considering the penalties, you don't want to withdraw early from a 401(k) if you can help it, especially if you're quitting your job without something else lined up. 

"The labor market is in a position right now where there's a lot of power on the employee, so they should be able to get another job sooner rather than later," says Rob Greenman, a certified financial planner and chief growth officer at Vista Capital Partners. "But that's not a sure thing."

Greenman suggests putting some "guardrails" in place before leaving your current job to prevent you from needing to make withdrawals. These include a topped-up emergency fund worth three to six months of your expenses, including monthly health insurance payments, and some sort of health insurance while unemployed.

He also recommends seeking out jobs that offer "happiness and purpose," not just more money. By ensuring that a new job is a good fit, you'll be less likely to quit the role because it makes you unhappy.

"The problem with 401(k)s is that you can withdraw from them a little bit easier. For example, you can't easily take $10,000 or $5,000 out of your house," says Greenman. "I think that's why we hear about that happening more frequently."

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