5 Reasons To Stop Funding Your 401(k)
When it comes to retirement planning, the 401(k) plan is the gold standard. Not only can you make tax-deductible contributions, but your money also grows tax-deferred, and you’re likely to get “free money” in the form of employer contributions as well. For this reason, most financial experts advise that you contribute as much as you can to your 401(k) plan on an ongoing basis. But are there any times when you might consider stopping your 401(k) contributions? Generally, only in dire financial situations like the ones listed below.
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You Lost Your Job
If you lost your job, you may have no choice but to stop contributing to your 401(k) plan. For starters, you won’t be drawing a steady income anymore — at least temporarily — so there will be nothing to contribute. Your ex-employer also won’t likely allow contributions to your plan anymore. On a completely practical basis, even if you were able to contribute something to your 401(k) plan, this is one of those rare times when you should likely take a break. Without a steady source of income, you’re better off funding your basic needs with whatever income you can generate than trying to save for retirement at this time.
You Have Overwhelming, High-Interest Credit Card Debt
Credit card debt is a significant drain on financial resources. With most credit card interest rates in the high double digits — often reaching 20% or more — paying down this type of debt should always be a top priority. Even the most aggressive 401(k) investment strategy isn’t likely to consistently provide a high double-digit return, but if you pay off your 20% APY credit card, you’ll be effectively receiving a risk-free 20% return on your money.
You Have No Emergency Fund
An emergency fund is the cornerstone of any financial plan. Without an emergency fund, you’re likely to go into debt if you have any unexpected expenses like a car repair or an uncovered medical bill. Of course, one of the things you can count on in life is recurring “unexpected” expenses, so having an emergency fund is imperative. If you don’t yet have one, stopping your 401(k) contributions until you’ve tucked away three to six months of living expenses is a prudent strategy.
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Your 401(k) Plan Is Terrible
Generally speaking, the tax benefits and employer matching features of a 401(k) make contributing to the plans worth it, even if the returns are a bit below average. But there are occasions when 401(k) plans can be so bad that you’re better off investing your funds elsewhere.
Some 401(k) plans simply have a poor lineup of mutual funds or other investments. This can include a roster of perennially underperforming investments or funds that charge excessively high fees. Other 401(k) plans might discontinue or disallow employer contributions, removing the huge boost that these supplemental payments can provide to your long-term account balance.
Choosing to discontinue 401(k) contributions for this reason can be a difficult decision because the advantages of these types of plans can be so great. But if you can get higher long-term returns through your own IRA or some other type of investment plan, it may make sense to stop funding your 401(k).
You Have No Tax Liability
One of the best reasons to fund a 401(k) is to reduce your tax liability. If you’re in the 35% tax bracket and contribute $10,000 to your 401(k) plan, for example, you’ll save a whopping $3,500 on your taxes. But if you don’t anticipate having any tax liability at all, you won’t get any tax benefit from contributing to your 401(k). Now, there are still plenty of reasons why you might still contribute to your 401(k) in this situation. But you may end up being better off if you can invest that money elsewhere until you are earning enough money to get a tax benefit from your 401(k) contributions. This can be a tricky distinction, so be sure to talk with your tax and/or financial advisors before you embark on this course of action.
Bonus: Bad Reasons To Stop Funding Your 401(k)
All of the above reasons to stop funding your 401(k) relate to your immediate financial security. But some people feel like they should stop funding their 401(k) plans simply when the stock market is down — or up. These are both poor reasons to stop your 401(k) contributions.
Successful long-term investing requires being in the market. Trying to time your investments almost inevitably leads to underperformance. Stopping your 401(k) investments when the market is down means you’ll miss out on any gains when the market recovers. In fact, most financial advisors would recommend you actually increase your contributions when the market is down, not eliminate them. Stopping your contributions when the market is up is also a mistake, as no one can say for sure what “up” actually means. The fact remains that over the long run, the market has a 100% track record for going on to set new highs, even if it takes a number of years.
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