The U.S. posted a record number of job openings in 2016. In many industries, experienced workers are hard to find, forcing companies to increase salary offers to lure employees away from their current jobs. Because of the shortage of talent, the 2017 job market is expected to be the strongest in years. That’s great for workers and could be great for their paychecks.
It might not be great for their retirement, however. Changing jobs can be an exciting time, but if it’s not handled correctly, job changers could sink their own retirement. A new job can mean new expenses or upfront costs associated with a move to a new city. It also can lead to pressure to prematurely withdraw money from a 401(k) at the old job. While hitting up a retirement account might be done with the best of intentions, it can have long-lasting effects on total retirement savings.
A new job doesn’t mean the old retirement account is irrelevant
According to a 2014 study by the Employee Benefit Research Institute (EBRI), cashouts after a job change are the worst offender when it comes to what it calls 401(k) “leakage,” that is, money taken from qualified retirement plans before retirement age. Surprisingly, cashouts after a job change cause more damage to retirement savings than either defaulted 401(k) loans or hardship withdrawals. EBRI estimates that two-thirds of all 401(k) leakage is due to job-change cashouts.
Job-change cashouts particularly affect younger workers. Short-changing their own retirement accounts early in their careers effectively erases 30-some years of potential growth. The negative effects of early withdrawals were seen across income brackets, with 25% of the lowest-earning quartile running into shortfalls in retirement and 10% of the highest-earning quartile seeing a shortfall (shortfall here is defined in terms of whether the retiree will have 80% of his or her former income in retirement).
Recognize that job changes are significant life events that come with their own pressures
Normally, prematurely taking cash from a retirement account is seen as a sign of economic trouble, not the consequence of getting a new job that should, in theory, be a great time in a person’s career. But that new job can also come with some pressing expenses, such as a move to a new location or a closet full of new clothes if the new office has a different dress code than the former one. And then there’s what could be the worst offender: the view that, because the new job has a higher salary, it’s OK to step up the level of discretionary spending because the increased cash flow will eventually pay for it.
Eventually, of course, never seems to come around. Medium-priced restaurants become high-priced restaurants; a $15,000 used car becomes a $30,000 new car, with accompanying loan; that old furniture from grad school becomes a pricey, solid-wood bedroom set; public school for the kids becomes a private school, an entirely new expense. But it’s all justified because there’s a new salary in town, and it’s supposed to be a lot higher. And then the first paycheck hits, and it’s only marginally higher than previous ones. What’s a worker to do when suddenly stretched for cash? For many, the answer has been to hit up the 401(k) plan from their prior job and cash out well before their retirement age.
Changing jobs is a time to celebrate (just don’t celebrate too hard)
So what’s a person who’s recently changed jobs to do?
- Celebrate. Come on, you got a new job. Live a little.
- Don’t celebrate too hard. In fact, try not to change your spending habits beyond the absolute necessities (such as paying to move to a new state, if the new employer won’t). Settle in to the new paychecks for a few months before you start committing cash to an upgraded lifestyle. Unless you make a conscious effort not to, you’ll easily find new expenses to soak up the increase in your paycheck.
- Take away the pressure to spend the new money by not having ready access to the money. If you can keep your spending stable, consider taking most or all of your pay raise and increasing your 401(k) contribution at your new job. Often, the new employer won’t allow or won’t match contributions to its own 401(k) until you’ve been at the job a certain amount of time, usually at least one year. That first year is a great time to open up a new IRA (or contribute to an existing one).
- Talk with a financial professional about what to do with your old 401(k) from your previous job, whether you should leave it where it is, roll it over into your new 401(k) (if you have one), or roll it over into a different qualified retirement plan. Sending the money straight to yourself could lead to taxes and penalties, so make sure you’re well informed about how to transfer any retirement funds before you do so. Don’t hesitate to talk to your new plan’s sponsor or to a financial advisor.