This post was originally meant to focus on how the fledgling economy is impacting our philosophies around saving for retirement. It still will, but with the added layer of job insecurity and prioritizing certain types of savings/investments.
It’s always seemed so easy and logical for my 20-something (alright, almost 30) self. Sure, retirement is but a wee spot in the distant future, but saving is the prudent and responsible choice. And my 401K was the magic bullet; the ideal savings solution!
I began contributing to my 401K the moment I became eligible at my first full-time job after college. In five years time I had amassed a small sum of money, which has now diminished by half. The same, sad story is echoed across the country,
“My 401K lost 5/20/50/100 thousand dollars! Half of its value!”
While it’s understandably upsetting to see such a large drop in retirement savings, it’s important to weed out some perspective from the current situation. Pulling money from retirement savings, decreasing 401K contributions or drastically changing investment portfolios are options that must be considered carefully and without emotion. Consider this before thinking about touching your 401K; this is a tax-deferred savings account, so depending on your tax bracket, there’s a 25-35% return on the money invested (now) from the get-go. This is before any market returns (or, as we’ve seen, losses) or employer matching.
Income does not decrease that much proportionately when you stop 401K contributions. I will use myself as an example, as the first thing that entered my mind when I heard about a pay cut was whether I should stop putting money into this account.
Prior to the pay cut I was making $3,560.48 monthly and contributing 3% (not much, I know) toward my 401K, $106.82 per month. I will now earning $3,382.46 monthly and my 401K contributions would be $101.48.
($3,382.46 x 0.97) = $3,280.99 Taxable Income
Taxable Income ($3,280.99) x Taxes (27%, 0.73) = $2,395.12
Taxable Income ($3,382.46) x Taxes (27%, 0.73) = $2,469.20
Please note, I have left medical expenses out of this equation.
If I stop contributing the 3% to my 401K, I will take home an additional $74 per month. $27.48 will go toward taxes rather than my 401K.
Normally, I would NOT recommend that anyone stop contributions. However, I took out a 410K loan earlier in the year (something I also do not recommend, but….I’ve never claimed to be a financial genius, right?) and I am considering halting contributions for the period in which I will be paying off the loan (6 months).
To be perfectly frank, my total desperation to pay down that high interest B of A card was clouding my judgment when I decided on the 401K loan. It was a small loan ($1,400) and I have very little in my account anyhow, and I scheduled to pay it down quickly, so I easily justified it. As I said, it’s bad news to make a habit out of this, so I don’t recommend it. I just figured I should be totally honest and fess up.
Modifying 401K Investments
We’ve discovered that 401K accounts are not the “magic bullet,” but they are still valuable. The trick is to realize that all accounts are not created equal. I know it can be intimidating and time-consuming, but do some research into your 401K investment options. The general rule of thumb when investing for retirement is that you should take on less risk as you get older (or, the closer you get to retirement). This means an investment portfolio heavy in stocks when you’re younger, transitioning into a more conservative portfolio as you get older.
At 29, I’m not all that worried that my 401K has dwindled by 50%, because I have 35+ to ride the market. This is an ideal time to educate yourself and take control of your investment portfolio. Depending on the 401K, owners often have a great deal of flexibility in choosing and diversifying their portfolios. Now is the time to focus on bear market funds and invest more aggressively, if appropriate given your retirement timeline.
Paying Down Debt V. 401K Investments
You can punch the numbers all you want, but I feel that this is a totally personal decision. One that should be based on the amount of your debt, what you’re 401K account looks like, your age, and how the debt is impacting your psyche. If paying off your debt more aggressively will push you to remain motivated and make you feel more sane, by all means, prioritize it. As lines of credit are SO hard to get these days, it might be prudent to halt (or reduce) contributions for a short period of time to focus on debt repayment.
I’ve always scoffed at this advice, not because it’s bad advice, but because it’s entirely unrealistic for the greater portion of the population. How is a person living paycheck to paycheck going to amass a respectable amount of money in an “emergency” savings account?
My opinions around this have changed with the job market being what it is. Respectable amount notwithstanding, a liquid savings account – even a modest one – is incredibly important to have in this climate. It could mean the difference between paying rent with cash or withdrawing money from a credit card at 30%. It could mean groceries for a month. I could mean having the money for your kid’s dental work instead of begging a family member for a loan.
For me, this means shifting some of the money meant for debt repayment and a vacation into an emergency savings account.
And yes, I am not happy about it.