LINCOLNSHIRE, Ill. -- Even though the number of plan participants choosing to cash out their 401(k) plans when changing employers has dropped, more than half of participants still take the money and run, according to a study by Hewitt Associates LLC.
"A lot of plan participants still view access to their money as a windfall, rather than keeping it tax deferred," said Mike McCarthy, a defined contribution consultant with Hewitt Associates, Lincolnshire.
Education or growth?
Fifty-seven percent of 401(k) participants took their plan assets in cash in 1998, down from 64% in 1993, the study indicated.
The question is how much of the decrease in the number of people who took a cash distribution is due to an increase in education by plan sponsors, and how much is due to the growth in the market, Mr. McCarthy said.
A growth in the market leads to a higher number of rollovers, he said. "People with more money are less likely to take the tax hit," Mr. McCarthy explained.
Plan participants pay a tax penalty of about 40% of their 401(k) account balances when they take the cash distribution, rather than deferring the taxes by rolling over funds into another qualified plan, according to Mr. McCarthy.
The data from the Hewitt survey came from analyzing more than 193,000 distributions from defined contribution plans in 1998. Hewitt conducted the first such poll in 1993.
Grabbing the cash
The smaller the balance, the more likely the employee is to take the cash payment, the study indicated. Seventy-eight percent of the plan participants who took distributions had balances of less than $5,000, the study stated.
Still, a fair number of 401(k) plan participants with larger balances also grab the cash, Mr. McCarthy said. Of people with balances from $25,001 to $50,000, 31% took the cash; and 17% of participants with balances between $50,001 and $100,000 cashed out.
People who opt for the cash lose a significant amount of money in taxes, he said.
"They do not realize they will pay 40%," Mr. McCarthy said.
"A lot of times people think about the 20% tax withholding rate. That rate is a down-payment on what the ultimate tax will be," he added.
Of those who did roll over their 401(k) balances, more directed it to an individual retirement account than to another qualified plan, the survey indicated. About 37% of 401(k) plan participants rolled over the payments to an IRA, up six percentage points from 1993.
And 6% of individuals rolled over their 401(k) funds into another qualified plan, up one percentage point from five years ago, according to the survey.
"The education has done fine as far as asset allocation and participants learning about the need to save, but they're not learning about it early enough," Mr. McCarthy said.
Plan sponsors should start giving the message to employees from the moment they are hired, he said.
"From the first time an employee walks through the door, employers need to talk about rolling over their former 401(k) money into the new employer's plan; and whenever the employee moves on or retires, they need to make the right decision then," Mr. McCarthy said.