What the Secure 2.0 Act will mean for early 401(k) cashouts

Yahoo Finance's Kerry Hannon joins the Live show to discuss the latest surrounding the Secure 2.0 act and how retirees can cash out of retirement funds early.

Video Transcript

DAVE BRIGGS: All right, it's a new year. For some, that might come with a new job and a new 401(k) plan. In 2021, Fidelity processed 1.1 million retirement fund cashouts for clients. And over half of those clients were under the age of 35. Cashing out comes with costly penalties if you're not at the age of retirement. But a new law will help encourage people to keep their money in retirement accounts. Yahoo Finance's Kerry Hannon has those details. Hi there, Kerry.

KERRY HANNON: Hey, great to be here. Yeah, this is good news for retirement savers. The new law, the SECURE 2.0 Act, which will kick in later this year, has this critical provision that allows your previous-- your former employer to automatically transfer your retirement balance in your 401(k), your 403(b), into your new employer plan without you having to do anything. It's very seamless. This is a big deal because it sort of paves the way for that to happen.

And it allows people to keep that money growing for them for future financial security because here's what happens, Dave. One in three workers cash out of their retirement accounts when they change jobs. And when you're between the ages of 20 and 30, that jumps up to, like, 41% of people do. And trust me, I did this myself when I was 30 years old, and I regret it. It was probably one of my biggest financial regrets that I have when I think about what that $5,000 might be worth today.

So what it is this money, if you have under $7,000 now, they can automatically transfer this. And so let me just give you a quick example. Retirement Clearing House ran these numbers that-- I ran it on their calculator. They have it on their site. If you're 25 years old and you have $5,000 in your 401(k), and if you-- assuming you have 5% return, and you're not adding anything more into that, if you take that money out at the age of 67, which would be your full retirement age, you'd have $38,808.

But if you decide that you're going to cash that money in right now when you skip-- when you're changing jobs, you would pay $500 to the IRS. And-- no, you'd pay $1,000 to the IRS, and you'd also have a $500 fine because before 59 and 1/2, it's a 10% penalty and taxes on the funds you withdraw.

So you'd have $3,500 versus if you just let it hang out. So this is really a big deal because a lot of people do change jobs, and they cash out. And/or if it's a small amount of money, they may even forget that they have it, and the employer, the previous one, rolls it into an IRA.

So I think this is really good news. Fidelity and Vanguard have been working on having a clearing house kind of thing that would enable this to happen. And the new law really jumpstarts this, which will help people hang on to that money, keep it invested in their retirement plans.

SEANA SMITH: Yeah, Kerry, when you're talking about that penalty, it really highlights why people need to keep their money invested in their 401(k). But I think a lot of people are faced with this new decision or a big decision when they're starting that new job, how much they should be allocating to a 401(k), how much they should be saving for retirement. How should people be thinking about those decisions?

KERRY HANNON: Yeah, I think, obviously, it's a personal decision. If you're trying to allocate for your new job, I always encourage people to try to at least save as big the percentage of your salary that at least you get your employer match, if your employer matches funds. So whether that's 5%, 7%, whatever it might be, try to do that. And you can auto-escalate that.

So each year, you can bump it up a little higher whenever you feel more comfortable. But the fact is, Seana, a lot of people cash out when they switch jobs. Like I said, I did. I did it to pay credit card bills.

And that's what happens. People cash out because you know what? They absolutely need the money to pay for medical bills. They're going through a divorce. Whatever it might be, they need the money. And so the point is it makes it very tricky to stay away from that money and keep it invested.

And that's why this new provision, I think, will allow people to seamlessly keep the money without feeling that they need to tap out. But I'm telling you, when you're 20 years old or 30 years old, retirement seems like a long time away. And it really feels unreal to you, and you're like, gosh, I need that money right now. So the more you can save, the better you'll be for your future financial security.

SEANA SMITH: To keep your money in your 401(k). Kerry Hannon, thanks so much for that--

KERRY HANNON: Thank you.

SEANA SMITH: --update there-- advice, I should say.