Reducing 401(k) contribution -- s/o
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Anonymous
Please help me get a sanity check here, and no snark would be appreciated. 
Due to circumstances beyond my control, DH and I are financially tight. Our debt payments are very high (medical expenses among other things) and the stretch is causing us to fall behind. We no longer have an emergency fund. I was thinking that I would stop 401(k) contributions for a year and use that money to get back on track. But looking at my 401(k), it's really made a lot of money over the past year. If I look at the amount of money it's made over the past year, plus my company contribution, I think I actually do better by several thousand dollars making a withdrawal and paying the penalty/taxes and keeping my ongoing contributions. Plus I would still be paying down some consumer debt at a high interest rate that's making us so squeezed. I know it's not ideal under any circumstances to do this. But do you see a flaw in my logic? |
Anonymous
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How old are you? That makes all the difference. We liquidated DH's 403b to buy a house, but we're early 30's. Not that risky.
If it's a close call (i.e. whether the withdrawal or ceasing contributions is a better bet) I would just go with ceasing contributions. |
Anonymous
| Can you borrow from your 401k? If you can do that, and are comfortable making payments and your job is secure, you might consider that. |
Anonymous
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The only way this would make sense is if you calculated what you in pocket money would be (withdrawl - 10% penalty - income tax%) and then take that cash and invest it into something that would beat your return + match.
Otherwise you would be throwing away a lot of money and it may be more expensive then paying down the debt. Calculate how much interest you would be paying vs. the withdrawal penalty + the income tax hit. |
Anonymous
| Stop your contributions. As you said, you've made a lot of money, and it will continue to grow (assuming the market continues to grow). With. Win. |
Anonymous
Yes, the flaw in your logic is that the penalty (10%) plus the tax on it as income (~25%) would be a 35% reduction. So if you took out $1000, you would actually only net $650. Plus you lose any compounding that you would have had on those funds in the future. I would either stop the contribution AFTER the match. If you get a 5% match from your company, do at least that. That's free money!!! You can also borrow from your 401K if you job is stable and they allow it. |
Anonymous
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Thanks all. The thing is, when I run the numbers I come out several thousand dollars ahead by making a withdrawal now vs. just stopping contributions.
So for example, last year I put in 10,000. I've achieved a 19% return this year, and got a company match worth 2250. So that's a total of about $14,250 = that's a year's worth of contribution and gain. If I take that year's worth out, subtract a 10% penalty and 28% taxes, I end up with about $9500 cash in hand. My 401K balance goes down $14250 but in the following year makes that back, as my contributions and company match continue. If I stop contributions, that's 10K minus 28% tax, so I will have a little over $7000 case in hand. Plus there's interest over the course of the year that I will be paying on my debt (since I don't get the benefit of more money all at once). And I lose out on the 2250 company match plus whatever that money would have made in the 401K. The big difference is the 10% penalty but that is more than made up for by the company match in the coming year. |
Anonymous
| Can I recommend a personal finance guy named Dave Ramsey? He's got a website and a radio show. Anyway, he recommends temporarily stopping 401k contributions if you're in debt in order to get out of debt. His notion is that you need to focus on the debt first before you worry about saving for retirement, especially if you're younger. In your situation, I would absolutely stop contributing for a year or two and direct that money towards my debt. You'll free up your cash flow once you pay off debt and be able to start contributing again. Now, I wouldn't do that if you were going to take the money you would have been contributing to your 401k and go on vacation. But I'd rather pay off debt than contribute to the 401k for a very short term period. I realize you might lose a few dollars over the long term but IMHO, the peace of mind of getting rid of the debt and having more cash flow would be worth it. |
Anonymous
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this year's return, 19%, is historic and NOT TYPICAL. Typical is more like 7% on average. Next year could be a loser year in the negative per cent. Don't go by the 19%.
Why not split the difference? My worry is that you would stop the contributions but the $ would get eaten up (literally) by eating out, coffee, vacations, gifts, parking tickets. And then you wouldn't have this wealth later in life (at age 51, I'm telling you, you look back and think "what in the hell was I doing with all that money at the time?!?"). Because at 51, I'm looking at what I have managed to save in my 401K and it's not enough to allow me to retire at my retirement age.... arrrgghhh! If you can squeeze by, do that. If not, contribute up to the match, whatever that is. Just keep a budget and be careful. |
Anonymous
You have no idea what you will make next year. The market could tank and you wouldn't make as much. Or you could have another unforseen major expense and find it more difficult to pay back the loan from your 401k. The safest and most prudent thing to do is to reduce contributions to the point where you get the full match, as PP said. Then apply the extra money toward your debt and don't allow it to get eaten up by anything else. And I would set a goal -- e.g., maybe you only reduce contributions for 3 months or 6 months, and not the whole year. Run the math on how many months you'd have to reduce and consider what's doable. I personally would feel uncomfortable going beyond a year. |
Anonymous
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I did some calculations and if I did them correctly, you should NOT withdraw, and you should reduce your monthly 401k pay contributions to the minimum that earns you the match, and pay off the debt with the balance. This assumed debt of $9500 (the amount you would pay back), rate of return on th e401k of 10 percent, and interest rate on debt of 20 percent.
If you do what I recommend, the net value of your 401k ($14,250 + monthly contributions of $375 (yours plus match) at 10 percent would be $20,500. At the same time you would have paid off your $9,500 of debt so that it would equal about $3,100. Your net worth would be about $17,400 (401k balance minus debt). For comparison, your plan would give you a net worth in a year of $12,800. |
Anonymous
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THanks PP -- that's exactly the help I was looking for.
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Anonymous
Phyllis Borzi, Assistant Secretary of Labor for the Employee Benefits Security Administration (EBSA), had this to say in recent testimony to Congress: From 1998 to 2007, the average annual returns for IRAs were 4.5 percent, compared with 5.4 percent for 401ks. IRA holders often pay fees that can be two to three times higher than the fees paid by employee benefit plan participants. |
Anonymous
| You should never take money out of a retirement account. Contribute up to the match. Cut back as much as you can on expenses. No manicure, no Starbucks, no eating out, stop buying new clothes. At Christmas give home made gifts. Ect. If you have already done that, which I doubt. Then earn more money. Walk dogs after work, get a paper route ect |
Anonymous
| We cashed out and bought multiple houses , best investment ever. |