Instead of cashing out, roll your money over or keep it with your former employer. If you left the same $5,000 in your employer's 401(k) or rolled it over to an IRA, you would have more than $34,000 for retirement, assuming an 8 percent annual return for the next 25 years.
If your account balance is less than $1,000 most employers just cash the employee out. And for those with a balance below $5,000 their money will automatically be rolled to an IRA, unless the employee chooses to cash out. For those with more than $5,000, I recommend moving your money to your new employer if your new plan has a diverse choice of investment options and if the employer provides some form of free investment advice for participants, such as online Web tools or seminars. As many people may have multiple employers and 401(k) plans, I recommend you role all assets into a single plan or IRA. It is much easier to keep track of one plan and to stay on top of your investment choices to make sure you are making the most of your plan.
The percentage of employees taking a loan against their 401(k) plans has more than doubled in the last two years. In fact, according to a study by Boston College, more than 18 percent of employees took out a loan last year against their 401(k). Taking out a hardship loan from a retirement plan should only be a last resort — it's not an ATM machine.
Before you take this step, which penalizes you in retirement — cut back on eating out, discretionary purchases like clothing and vacations, fuel costs, and so forth. The math works out that for every $10 you take out from your account, you really have $6 or $7 to spend thanks to the fees and to the time value of money — less money to reap the benefits of compounding.
Mellody Hobson, president of Ariel Investments in Chicago, is "Good Morning America's" personal finance expert. Click here to visit her Web site, www.arielinvestments.com. Matthew Yale contributed to this report.