Don't count on inheritance to pay for your retirement

By Sandra Block
USA Today

Your parents have helped you in more ways than you can count. They put you through college, gave you a place to stay when you were out of work and helped you buy your first home. They even picked up the bar tab for your wedding.

But if you're counting on them to finance your retirement, you could be in for a big disappointment.

A new study by AARP suggests that most boomers will receive a small inheritance, if they get anything at all. As of 2001, only about 17 percent of boomers had received any inheritance. Those that did receive money didn't get much, AARP says. The median inheritance was $47,909.

This wasn't supposed to happen. A few years ago, studies predicted that boomers would inherit trillions of dollars from their parents, a comforting thought for people who hadn't saved much for retirement. But those studies failed to take into account longer life expectancies, soaring healthcare bills and long-term care, AARP says. All those factors can erode retirees' savings, reducing the size of their children's inheritances.

In addition, a large chunk of retirees' assets aren't transferable. Pensions and Social Security, which can't be left to heirs, account for about half the wealth held by people age 50 and older, AARP says.

For baby boomers, the results point to an inescapable conclusion, says John Gist of AARP: "It means they're going to have to save more."

Yet, several other recent studies suggest boomers aren't getting the message. Hewitt Associates, a human resources consulting firm, recently reported that more than 40 percent of workers who switched jobs last year cashed out their 401(k) plans instead of rolling the money into another retirement savings account. Another survey by Plansponsor.com found that the average participation rate in 401(k) plans fell 3.6 percentage points this year to 72.6 percent.

The Hewitt study is particularly troubling because a cash-out will leave permanent scars on your retirement portfolio. You'll have to pay income taxes on the withdrawal, plus a 10 percent penalty if you're under age 59 1/2. You'll also give up years of tax-deferred compounding.

Unfortunately, the cash-out trend isn't limited to the young and the restless. While cash-outs were highest among workers ages 20 to 29, about a third of job changers ages 50 to 59 took their 401(k) distributions in cash.

While the greatest percentage of cash-outs involved plans valued at less than $10,000, 20 percent of job changers with a balance of between $40,000 and $49,000 opted to take cash and enrich the federal government.

Some workers cash out 401(k) plans because they need the money to pay bills. But many cash out because they don't want to go through the hassle of transferring their money to an individual retirement account, says Stacy Schaus, a consultant with Hewitt.

Some better alternatives:

• Leave the money in your former employer's 401(k) plan. This alternative isn't available to everyone: Employers are allowed to force departing workers with less than $5,000 to roll over their savings or cash out. But if your account is worth more than that and you like the investment choices in your 401(k), leaving your money with your former employer is a good strategy, Schaus says.
• Set up an IRA with the financial institution that manages your 401(k) plan. The firm that manages your plan may offer an easy way to roll over your savings into an IRA, Schaus says. First, though, compare the firm's investment options and costs with those offered by other IRA providers.
• Roll the money into your new employer's 401(k). Not all companies allow such rollovers, but if you like your new employer's plan, a rollover will allow you to consolidate savings in one place.
• Try to avoid cashing out your entire savings. Remember, if you cash out your 401(k), you'll pay taxes and penalties on the entire amount. A better strategy: Roll over your money to an IRA, then withdraw what you need. That way, you'll only owe taxes and penalties on the amount you take.