Job change? The one decision that will wreck your retirement

When you move on to a new job, you have an important retirement decision to make. If you had a workplace retirement plan, such as a 401(k), at your old job, you must decide what to do with that account. About one-third of job hoppers in their 20s, 30s and 40s make a decision that can wreck their retirement: They cash out the money.

When you leave a job, you typically have a few options for what to do with your 401(k) savings:

■ Leave it behind. If your account value is at least $5,000, you can leave the account with your old employer. You won’t be able to make any new contributions, but your savings can stay put and continue to grow.

■ Move the account to your new employer’s plan. Some employers will let you bring your 401(k) assets with you, which is called a 401(k) rollover, transferring your money into their plan.

■ Move the money to a rollover IRA. You can make a tax-free transfer that sends your 401(k) money to an IRA account you have at a discount brokerage.

■ Cash out the money. This is indeed an option. You can cash out all of the money or just a portion of it.

The high opportunity cost of a 401(k) cash-out

There are plenty of reasons — and temptations — that can make cashing out seem compelling. Maybe you’re determined to wipe out some high-rate credit card debt, or take a much-needed vacation before you start your new job, or buy a new car to go with the new gig.

The first problem with this move is the tax hit. If you cash out a traditional 401(k), you will owe income tax on the withdrawal. And if you are younger than 55 when you cash out, there will also be a 10% early withdrawal penalty.

But the bigger issue is that you’ve reduced your retirement savings. By a lot more than the amount you withdraw. An academic study estimated that cashing out can reduce eventual retirement wealth by around 20%.

That’s because when you cash out today, you’re giving up years when that money could continue to grow tax-deferred.

For example, let’s say you are 30 and land a great new job. You have $50,000 saved up in the 401(k) at your old employer. You decide to cash out $10,000, but feel good that you are leaving the other $40,000 to keep growing. That’s going to be a very costly decision.

The $40,000 will grow to $427,000 by age 65 assuming an annualized return of 7%. But if you had kept all $50,000 working for you, it would be worth nearly $535,000. That’s not a typo. Your seemingly “small” cash-out of $10,000 ends up costing you more than $100,000 in retirement wealth.

And remember, if you cash out $10,000, you’re not going to pocket $10,000. The 10% early withdrawal penalty cuts it to $9,000 and then you’ve got the income tax to contend with. Let’s assume that eats up another 20%, so you’re left with $7,000 on a $10,000 cash-out.

The next time you job hop and are considering a cash-out, slow down and consider the potential six-figure opportunity cost of making that move. Keep the money growing for your retirement, and