I was on a debt and credit virtual meet-up this past weekend and a participant asked an intriguing question. Given the turmoil in the economy now due to COVID-19 and rising debt, she asked if now was a good time to stop contributing to her 401(k) and pay debt instead? That question really made me perk up!
Her rationale was to shift her income to paying down debt versus saving for retirement. This is a common question, but it is not as black-and-white as it may seem. For starters, you need to examine the interest rates on your debts. You also need to look at what kind of debts you have. And, importantly, whether you are falling behind on any of those debts. And, even more important, how many years from retirement are you?
With debt, there is a myriad of options you can take to address repaying, delaying, or whether you should even pay the debt. That could be an entirely separate blog post on its own. When it comes to retirement savings, you don’t have as many options and you can’t afford to delay. Mainly, you need to save while you are earning, and you need the magic of compounding over time to assist you. You can’t get to retirement and then start thirty years of savings and investing to pay for your retirement. You also cannot borrow to fund your retirement.
If you are in a dire situation and your debt is out of control, there is one option to consider. That is, to do both. I am not advocating that you stop saving for retirement, but you can temporarily adjust how much you are saving.
Let’s say for example she is contributing 10% of her salary to her 401(k) plan. Her company offers a 100% match on the first 6% of salary that she contributes. She is, in essence, saving 16% for retirement thanks to the free money from her employer. Free money is awesome!
Although saving at a higher rate for retirement is always preferable, there are times when you may have acquired too much debt. If this is high interest, or revolving debt, it’s a concern. Our virtual meeting participant could actually split the difference and continue contributing to her 401(k), but also give herself a little raise temporarily. In this case, she could consider temporarily reducing contributions to her 401(k) plan from 10% to no less than 6%. Why 6%? She doesn’t want to give up on the free money from her employer via the 100% match on up to 6% of salary (or, whatever the employer matches). If she reduces her contribution from 10% to 6%, she is basically giving herself a 4% raise in income to be used temporarily for debt reduction. Reduce your contribution, but not below the employer match.
I stress again that this should not be a long-term solution. Once the debt is paid down, revisit your 401(k) plan and increase your contributions back to 10%, or more if you can. If it’s been a few years, and you are closer to retirement, you should contribute as much as possible to make up for the lost time.
As an independent Certified Financial Planner™, I can help you with these situations. Planning is more than making a single decision without considering your whole financial picture. Contact me and let’s get started, or at least subscribe to this blog. #talktometuesday #getstarted #HowIcanHelpYou #GetHelp #Hireaplanner #COVID-19 #CFPPro #savemoney #debt #whichtopayfirst #401k #retirement