This one gets filed under the topic of stupid mistakes that should never be made. This article at marketwatch.com gives some disturbing statistics about how common it is for people to cash out their 401K when leaving a job.
"Among workers in their 20s, 66% cashed out their plans compared with about 31% of workers in their 50s"
I was shocked to see those numbers. Cashing out of a 401k before eligible to do so under the law is like taking money out of a bank and giving the teller a huge tip.
"...workers pay a steep price to pull the money out: an immediate 20% withholding (which will be adjusted up or down based on their marginal tax rate when they file their tax return), plus a 10% withdrawal penalty."
This demonstrates my most important message. If you aren't rich or doing better than most of your peers, then, chances are, you only have yourself to blame. What could be the reason for giving up 30% of your money, money that you worked for? Why would you do that to yourself? And people wonder why they can't seem to stay ahead.
What are the alternatives? Well it's good to see that you care. The smartest move when changing jobs is to roll over your 401k balance to an IRA. There won't be any penalties and it will continue to grow tax-free until you can legally begin withdrawing the money. This website is just one example of a site I found with a simple search on Google. I don't know anything about this site but the information on rolling over a 401k is right on target.