Retirement planning took a backseat in many Americans’ minds in recent months as more pressing financial matters arose. Things like persistent inflation and the resumption of student loan payments have been taking a toll on peoples’ wallets as of late.
With lingering talks of a looming recession, it could be tempting for some to pause their 401(k) contributions.
A Pause Gives You More Cash
Andrew Latham, CFP and director of content of SuperMoney.com, said it’s an understandable urge to have during times like this. After all, you’d benefit from increased liquidity, which would provide you with immediate access to cash during periods of job loss, unexpected expenses or inflation.
“This cash could act as an emergency fund, which is a key component of a well-rounded financial plan,” Latham said.
But he said stopping your 401(k) contributions also could come with drawbacks.
“Your 401(k) not only provides you with the benefit of tax-deferred growth, but you also could be missing out on employer match contributions,” he said. “Moreover, when you halt contributions, you reduce the money invested in the market, missing potential rebound gains if the market recovers.”
Instead of stopping 401(k) contributions altogether, he recommends you consider diversifying your investment portfolio to include more recession-proof assets.
“Focus on building an emergency fund in a high-yield savings account to cover 3-6 months of living expenses,” he said.
When Pausing Your 401(k) Is Advisable
But, are there instances when pausing 401(k) contributions is a good idea?
According to Bobbi Rebell, CFP and founder of Financial Wellness Strategies, if given a choice between making ends meet or contributing to a 401(k), it might make more sense to lower or pause contributions rather than end up in debt.
“Financial decisions are not made in a vacuum,” Rebell said, “and we have to be realistic about what we can and cannot do toward reaching our long-term goals. Life is not perfect. Unfortunately many economic circumstances are out of our control and being in denial about shorter term financial needs can be just as precarious as not planning for the future.”
She added that there also needs to be a plan to catch up on your contributions.
“Another smart move might be to set up an automatic resumption of contributions at a given date,” she said, “knowing it can always be paused again if needed.”
In fact, Morningstar conducted an analysis comparing an investor who continued contributions versus one who paused investing during three bear markets: 2002, 2008 and 2020. The results found that the one who continued to contribute came out on top in each scenario.
“Putting contributions on hold while a 401(k) is losing money leaves you with fewer dollars that can benefit from an eventual rebound,” according to Morningstar. “Not only is it tough to get the timing right for a market recovery, but keeping money on the sidelines means betting against the odds. Statistically speaking, the market goes up more than it goes down. Watching a 401(k) lose money isn’t fun to live through, but things eventually turn around.”
The Power of Compounding Interest and Ignoring Free Money
Another study, How America Saves, conducted by Vanguard, found that 401(k) participation rates are at an all-time high and nearly a quarter of Americans said they have saved at least 10% of their income for retirement despite a challenging market environment in 2022. In addition, the study found that nearly 98% of retirement plan participants are offered some type of employer contribution.
Maria Bruno, CFP and spokesperson at Vanguard, said, “Regardless of economic conditions, it is important that investors contribute at least the amount that allows them to receive a company match.
“If an investor decides to pause or stop contributions, they are not only slowing their own compounding progress, but they are leaving the match — which can be thought of as free money — on the table. The best plan of action for long-term investors is to stay the course with their retirement savings efforts.”
Bruno also acknowledged that some people will need to balance retirement savings with other critical short-term financial objectives.
“For investors who are carrying high-interest rate debt, it’s financially advantageous to work on paying this down,” Bruno said. “In addition, it’s important to keep an emergency reserve of at least two weeks’ expenses so that any type of spending shock could likely be met. From there, work on incrementally maxing out tax-deferred retirement accounts. For example, set up an annual auto-increase on a 401(k) so that it slowly boosts retirement savings in a disciplined fashion.”
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