Investing in a 401(k) is a fairly hassle-free way to build your retirement savings — but there are certain times when you should forego investing in a 401(k), like if you have more pressing financial problems, such as debt. While you will eventually be able to save for retirement, if you have issues that need addressing right away, it might make sense to put that off. For help figuring out how to prioritize 401(k) savings and other financial issues, consider working with a financial advisor.
Reason to Forego 401(k) Contributions #1: You Have No Financial Safety Net
Putting money into a 401(k) doesn’t make sense if you turn around and pull it right back out again. According to a recent TIAA-CREF survey, nearly a third of Americans have borrowed from their retirement account at some point. Approximately 35% of those who took out a retirement loan did so to cover emergency expenses. Should you end up leaving your job before the loan is repaid in full, you could end up owing income taxes on the money along with a 10% early withdrawal penalty.
If you’re constantly raiding your retirement account to cover unexpected costs, it’s an obvious sign that you might need to defer your contributions and work on building up some cash reserves instead. Having a cushion in place can help you keep the rainy days at bay and you won’t have to worry about keeping up with loan payments or getting hit with a big tax bill.
Reason to Forego 401(k) Contributions #2: You’re in Debt
When you’re dealing with the debt demon, it takes a certain measure of intensity to get it paid off. If you’re being charged hundreds of dollars in interest each month, that’s a big incentive to zero out your balances once and for all. The money that’s coming out of your paycheck and going directly to your 401(k) could help you reach your debt-free goal that much faster.
If you’re not sure whether it makes sense to temporarily suspend your contributions, consider how much you’re paying in interest versus the kind of returns you’re getting on your investments. If you’re shelling out 15% or 20% to a credit card company but you’re only seeing a return of 5% to 8% on your 401(k), you’re basically going in the hole. Using the money to accelerate your debt payoff frees up more cash in your budget that you can then use to play catch up with your retirement savings. (Of course, just remember that you lose out on compounding interest when you delay retirement savings and some financial experts would advise contributing even a small amount to a retirement account is a good idea as you dig out of debt.)
Reason to Forego 401(k) Contributions #3: Fees Are Excessive
Investing in a 401(k) may not offer any real advantages if the amount of fees you’re paying counteracts any returns you might see. The Department of Labor instituted tougher regulations in 2012 to make fee disclosures more transparent but many participants still remain in the dark about how much they’re actually paying. According to a study from researchers at Yale, 16% of retirement plans analyzed had fees that completely negated the tax benefit for young savers.
Parking your money in an IRA instead means you won’t be able to save as much since the annual contribution limit is lower but you may be able to escape some of the hefty fees. If you’re not planning to stay with your current employer for a significant period of time, not participating in their plan (and contributing to an IRA instead) saves you the hassle of trying to roll it over once you move on.
Reason to Forego 401(k) Contributions #4: You’re Worried About the Long-Term Tax Implications
Contributions to a 401(k) are made on a tax-deferred basis which means you don’t actually settle up with Uncle Sam until you start making withdrawals. If you’re expecting to shift into a lower tax bracket when you retire, that’s probably not a big deal but it could be a problem if you’re expecting your income to increase.
When you’re planning your tax strategy, you want to consider every source of retirement income to see how things balance out. If, for example, you’ll be receiving pension benefits, Social Security and distributions from an IRA, throwing a 401(k) into the mix may result in a much higher tax liability. There’s no way to predict the future tax rates but hedging your bets may work in your favor if there’s a major tax hike down the line.
Bottom Line
We’re not saying that you can afford to put off saving for retirement indefinitely or that 401(k)s don’t have a certain amount of value. What ultimately matters most is how well you’re able to fit building a nest egg into the bigger financial picture and finding the best way to do that for you.
Retirement Planning Tips
- If you’re not sure how to approach saving for retirement, consider talking to a financial advisor. They can evaluate your current financial situation and help you figure out what will work best for you. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- While living off of Social Security alone would be tough, this source of government income can help you close any income gaps you might face in retirement. Check out SmartAsset’s Social Security calculator to learn how much you could receive.
Photo Credit: Photo credit: ©iStock.com/AndreyPopov, ©iStock.com/TheaDesign, ©iStock.com/Casper1774Studio