5 reasons not to contribute to your 401(k)
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By Cliff Goldstein
About Cliff
Cliff N. Goldstein is a member of the personal finance team at NerdWallet, an unbiased source of tools
and information aimed at helping consumers make smarter financial decisions. He
previously worked as a financial investment professional in the Private Wealth
Management division at Goldman Sachs, where he provided comprehensive financial
solutions to high net worth individuals, families and foundations. Cliff's
efforts are currently focused on building tools and writing articles to help
people better understand the complex financial advisor landscape. He helps
manage NerdWallet's "Ask an Advisor" platform, which enables people to receive
professional answers to their financial questions while also streamlining their
search for a financial
advisor ideally suited to their unique needs. Cliff holds a bachelor's
degree in International Economics from Georgetown University's Walsh School of
Foreign Service and received an honors certificate in International Business
Diplomacy. Follow Cliff on Twitter @CliffNerdWallet.
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One of the most common pieces of retirement advice is to max out
your 401(k). Many people — finance gurus included — are convinced this is a
surefire way to secure a prosperous life after work.
The truth is, contributing to a 401(k) isn't for everyone. We'd like to
believe in a single universally applicable panacea for retirement
planning, but it simply does not exist. Everyone has a unique set of
circumstances, needs and goals that will determine the appropriate course of
action. In certain situations, dumping money into a 401(k) is imprudent. Here are five reasons why you wouldn't want to buy into your company's 401(k) plan:
1. You don't have an emergency fund
Everybody needs one. Before saving, spending, investing or pretty much anything that involves moving money around, start by setting up an emergency fund. In the unfortunate case of a job loss, medical emergency or other personal crisis, you'll want to have the assets necessary to carry your family through to safety. Generally, the recommended emergency fund is equivalent to six months of income.
Establishing an emergency fund first is imperative. You don't want to be forced to dip into your 401(k) when hardships arise. Early withdrawal is a costly prospect. You will often be required to pay a 10% penalty fee on top of income tax, plus you're removing assets with tax-advantaged growth potential. There are some narrowly defined exceptions to the penalty, but most people will pay dearly for early access to those funds.
2. Your employer doesn't match contributions
One of the greatest benefits of a 401(k) comes from employer matches on contributions. If you're lucky, your company will agree to match your contributions up to a certain amount. You should almost always meet the company match. It's basically free money. Whether you contribute beyond the match is a decision you'll want to make taking into consideration your other investing options.
Unfortunately, many employers that offer a 401(k) plan don't match contributions. In that case, there are often better investment strategies. Since the money you contribute to your 401(k) will be taxed later in life and often has limited investment options, you may want to opt for an alternative retirement savings account, such as a traditional or Roth IRA.
3. You're swimming in debt
Investing in a 401(k) is a great way to grow your money, but it won't do much good if debt is simultaneously eating away at your accounts. Just as the interest on your savings is compounding to build your assets, so the interest on your debt is compounding to tear them down.
You should generally prioritize paying down current debts before stashing away money for the future. The sooner you pay what is owed, the less you'll lose to interest rates. There may be exceptions to this rule if your company has a generous 401(k) match, so you should probably find a financial advisor to help you in this scenario.
4. You fear future tax increases
Part of the allure of 401(k)s is the ability to defer income tax. You are not taxed on your contributions until you make withdrawals during retirement. However, it doesn't always make sense to defer taxes rather than paying up front.
Currently, the highest federal tax bracket is 39.6%. That may seem high, but historically, it's fairly low. In 1980, the highest bracket was 70%. In 1960, it was 91%. By the time you hit retirement, the country could be back at sky-high levels. Some people may deem it wiser to pay taxes now while rates are reasonable. Of course, predicting the tax brackets of 2030 is as big a gamble as spinning a roulette wheel in Vegas, but it's certainly something to consider.
- Also see: Judge got the facts wrong in 401(k) case
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