Why some walk away from 401(k)

Tax breaks. Matching contributions. It's one of those deals you can't pass up. The 401(k) and similar retirement plans offer several benefits to encourage people to save for their golden years. No wonder they're so popular.

But surprisingly, more and more Americans are letting those benefits slip through their fingers.

To begin with, a small but rising share of eligible workers are not participating in the plans. And many of those who do invest are "cashing out" when they leave their employer, according to a recent study. This despite heavy tax penalties that can cut their investment by nearly half.

Those are the kinds of moves that can send financial planners through the roof.

"People view saving for retirement as something they can do later," says Nevin Adams, editor in chief of Plansponsor.com, a retirement-industry trade publication. "They think they have time to start saving for retirement."

In fact, delay complicates saving (because money has less time to grow), planners say. Worse, workers who don't enroll in retirement plans are turning down free money.

Nevertheless, because of economic hardship or various other reasons, a growing number of Americans are opting out of retirement savings. Currently, about 73 percent of eligible employees are enrolled in 401(k) and similar retirement plans, Plansponsor.com found. That's down 3.6 percentage points from last year, which also experienced a 2.5 percentage point decline from the year before.

Meanwhile, an analysis of 160,000 employees found that 42 percent of them took their 401(k) balances in cash when they changed jobs, instead of rolling this money into IRAs or transferring the assets to their new employers' plans, according to Hewitt Associates, a benefits consulting firm based in Lincolnshire, Ill. While workers of all ages took distributions in cash from their 401(k)s, the highest incidence was among workers age 20 to 29. Half of these people cashed out their plans, the Hewitt study found. Even many of those with more to lose in terms of taxes and penalties failed to maintain the tax deferral of their 401(k)s: One-third of workers age 50 to 59 cashed out.

Workers did this despite multiple tax penalties. Premature withdrawals from 401(k)s are subject to federal income tax, a 10 percent early-withdrawal penalty, and any state tax. These taxes and penalties can cut the money left in the account by almost half.

For example, a $5,000 balance could grow to more than $38,000 in 30 years, assuming a 7 percent growth rate. But if the $5,000 is taken in cash, a person would receive only $2,850 after taxes, assuming a 28 percent federal tax, a 10 percent early-withdrawal penalty, and a 5 percent state tax.

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