"Cashing out" means you take your money out of a tax-deferred retirement savings account. Why would you do that?
You've got a new job and want to use the money in your former employer's retirement plan to pay off credit cards.
You've gone from two incomes to one because your spouse was laid off.
You want to buy a new car or take a vacation.
You pull out of growth investments because you're tired of losing money in a down market.
Avoid cashing out your savings because you'll generally pay a 10% penalty if you're under age 59½, plus you'll pay taxes on the money you took out. More important, you're giving up continued tax-deferred growth of those savings.
Here are two scenarios:
John has an $18,000 balance in his former employer's 401(k) plan. He decides to cash it out and pay off his car. Taxes and the early withdrawal penalty take $7,200 of his $18,000, leaving him with $10,800.
Instead, he decides to keep that $18,000 in a 401(k) or put it in a rollover IRA. If John averages a 6% rate of return over 32 years, he'll have $116,161 at retirement.
Your retirement savings should stay invested until you retire.