The money you forfeit when you cash out of your 401(k) can be staggering

(CNN) — When you quit your job, one of the biggest decisions you’ll have to make is what to do about the money in your retirement account if you’ve been saving in your company’s 401(k).

You typically have three options: Leave it where it is if the employer allows that. Roll it over to another tax-deferred retirement account such as an IRA or the 401(k) at your new job. Or just cash it out.

While a majority of 401(k) participants who switch jobs choose the first or second option, a large minority cash out, according to recent studies. It’s on average 33%, according to Vanguard Investments, analyzing data from more than 1,500 401(k) and 403(b) plans covering nearly 5 million participants.

A recent study from the Yale School of Management, meanwhile, examined a far smaller sample of nine company 401(k)s, each of which had both auto enrollment and auto escalation features — meaning employees had to actively opt out of participating in the 401(k) or opt out of automatically increasing their savings rate every year. In this sample, 40% of participants cashed out when they quit.

The true costs of cashing out

Vanguard found those more likely to cash out their 401(k)s are younger workers, and workers of all ages with smaller account balances (i.e., under $25,000).

The temptation to do so — especially if you’re in a tight spot financially — may be tough to resist. But there are three reasons to try to hold off if possible: Taxes, penalties and the loss of long-term investment growth.

For example: Consider a 30-year-old employee who lives in a high-tax area like New York City or Los Angeles. If she cashes out an account balance of $15,000, she could be out thousands of dollars the year she takes the payout and much more over time.

Taxes and penalties: Assuming the employee makes $85,000 and pays a combined federal, state and local tax rate of roughly 30%, she will pay between $4,500 and $4,695 in taxes on the cashout plus a 10% early withdrawal penalty of $1,500, according to estimates from Robert Persichitte, a Colorado-based certified public accountant, and Tom O’Saben, director of tax content at the National Association of Tax Professionals.

In other words, she’ll be out at least $6,000 and net no more than $9,000 from her original $15,000 in savings.

If her income is $55,000, O’Saben estimates she’ll pay $5,250 in taxes and penalties, netting $9,750.

Lost growth: The biggest hit of all is not going to be readily apparent. It’s the money that the employee would have earned had she left that $15,000 invested in a tax-deferred account for the next few decades.

Assuming it would be invested in a low-cost S&P 500 index fund over 30 years, it could grow to more than $260,000, assuming an average 10% annual return. Or if you assume a more modest 7% average return, it would grow to roughly $115,000.

Plainly put, “Cashing out of the 401(k) before 59-½ is one of the most expensive things a person can do, both from a tax perspective and an investment perspective,” said certified financial planner Paul Brahim, president-elect of the Financial Planning Association. “It creates permanent impairment of capital that can substantially affect their retirement income security in the future.”

Other potential hits to your savings when you quit

Another recent Vanguard analysis found that even if you don’t cash out an old 401(k) when you get a new job, simply changing jobs may reduce your retirement savings over time unless you’re diligent.

“The typical US worker has nine employers over the course of their career. The median job switcher sees a 10% increase in pay but a 0.7 percentage point decline in their retirement saving rate when they switch employers,” Vanguard noted in its report.

Here’s why: The features of a 401(k) plan may differ from employer to employer. While many now auto enroll employees in the plan, the default savings rate coming out of your paycheck may differ. If your new employer sets a lower default rate than your old one, be proactive about matching or exceeding what you were saving in your old job, So, for example, if you were saving 3% of your income at the old job, but your new employer has a 2% default rate, keep saving 3% or more at your new job.

Otherwise, there may be less money in your future. “For a worker earning $60,000 at the start of their career who switches jobs eight times across employers (for a total of nine jobs), the estimated loss in potential retirement savings could be $300,000 — enough to fund an estimated six additional years of spending in retirement,” Vanguard said.

And when contemplating a new job offer, don’t forget to compare the employer match you would get with the one you currently have, because that money is part of your total compensation package.

Check, too, how long the vesting period is at the new job — that’s the length of time you need to be at a company for the employer matches to be fully yours. In other words, if you take a new job before the vesting period ends, you will lose out on some or all of those matches.

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