I was wondering what you thought about our decision not to start contributing to a 401k until we are out of debt. My husband and I are both early 30’s and while it scares me sometimes that we have not even started saving for retirement, I feel a stronger need to get out of debt first. We have a long way to go on our debt-free plan (four to five years), so I don’t know if we should try to do both at the same time, because it would slow the debt payoff. What would you do if you were in our shoes? Thanks for your advice! -Alysia
The question of continuing retirement investing while paying off debt or getting onto a better financial footing is a tough one. There are many opinions, but you specifically asked what we would do so that makes it much easier.
I started retirement investing about a year after graduating from law school. At the time, I was working for a government agency and was not eligible to contribute into the State’s retirement system, because I had not been working as a full time government employee long enough.
I had the opportunity to take advantage of a deferred payment plan, but elected to keep more of my paycheck to help us get our emergency fund established. Once we reached our $1000 emergency fund level, I cut up the credit card I was keeping from law school supposedly for “emergencies.” Having the same amount of cash that I had as a credit level made me feel a lot more free to get rid of the thing.
It was not until then that I sat down and began planning for retirement. Because we were in our late 20’s, I opted to only throw a couple hundred dollars at it monthly through my automatic investment program with the mutual fund provider. This allowed us to save more towards our short-term goals. I know Dave Ramsey may not approve, but that is what I did because it fit our budget and our plan.
When we started saving in earnest for our house, I stopped retirement savings and funneled everything to that savings goal. My thinking was that we are young and would much rather have a paid-for house now and catch up on our retirement savings later. However, if we didn’t have the blessing of a good income and low expenses and it was going to take us longer than five years to pay cash for a house, we likely would have tweaked our plan and saved for retirement while we were saving for a house.
So, to answer your question, yes, I would (and did!) stop retirement in the short-run to build momentum to meet short-term savings goals but only if this would put us in a better long-term financial situation.
If it is just saving for a vacation or a new car, forget about it. Nothing in the short-run, apart from paying cash for a house or paying off debt, would deter me from taking advantage of the Eighth Wonder of the World in my retirement account — compound interest!
Jesse Paine is a licensed attorney who owns his own law firm. He’s married to Crystal and is the numbers nerd of the MoneySavingMom.com team! If you have a question you’d like him to answer in a future column, you can submit it here.
The content of this column intended for informational use only and is not to be construed as providing legal, investing, accounting, or other professional advice. Your situation is factually specific and you should accordingly seek qualified professional counsel concerning your specific legal, investing or accounting needs.
Thanks for your quick reply. I’ve just started doing the Financial Peace University by Dave Ramsey and I am looking forward to it. Seems time is not on my side but it is what it is. Thanks for your advice.
Have been reading the comments and the blog for a while now and I would be interested on reading your thoughts about my retirement plans or lack thereof. I am approaching 40 and have worked for an hourly wage my whole life. I don’t have the option of a 401k from my company. Retirement has just not been something I considered. I didn’t have that luxury or it seems the right life lessons from my parents. I have 2 kids under 7 no debt other than a mortgage and I hope to pay that off in the next 5 years. What would you do given this situation? Oh, I live in one of the most expensive cities on the US.
@Julie,
IMHO, I would create a budget and figure out how much money I could save per month. I would then head to a friend-recommended financial advisor (or two) and speak with them about what they recommend as savings vehicles. A Roth might be a good option. Also, the advisors should be able to run reports showing how much you need to save now to meet your retirement goals. This info from the advisors should all be free. The advisor will typically get a small percentage if you invest with them – when you earn money then they earn a small percentage of that. Even if you end up not going with them for whatever reason, it can be a great learning experience.
I was just downloading the free ebook ‘Debt Free For Life’ (that Crystal blogged about). While it was downloading, I looked at the budget calculators on the walletpop website. There is actually one that is called “Should I pay off debt or invest in savings?” Here is the site: http://www.walletpop.com/calculators/budgeting/
My husband is a financial advisor for a major investment firm. We have followed a very similar plan as Crystal and Jesse.
(1) contributed to 401ks to get employer match
(2) paid off first home ($200) in 2.5 years
(3) bought a second home / investment property and paid it off in another 3 years – now making great monthly income from it
(4) sold first home and bought new home ($450) once children were born and plan to have it paid off next year (in 2.5 years time)
We both have good incomes and we have a good nest egg which is completely in the market. We also have a full college savings saved for our two kids. We will bump up our investment contributions once the new home is paid for (could liquidate market account and pay off now, but not worth it to us), but it is very peaceful knowing that money is not all tied into just the market. There is something to be said about having zero debt and living in a home that we know we could afford even if we both lost our jobs. Money is an emotional topic and sometimes you have to look at it not just from the pure financial angle, but from an emotional one too. Everyone’s situation and risk tolerance is different and people need to make financial decisions that they can sleep with.
Thanks, Jesse, for taking the time to answer such a tough question. I don’t think there is a “right” or “wrong” answer when it comes to this, it’s very situational. But I thought your advice was really good. Thanks again!
A little input- I know several people went wild when Crystal talked about a home and the benefits you could accrue with interest. I think the recent recession has been a wake up call to the fact that interest is not a guarantees income or solid money lost. Yes, historically it is there and we definitely plan on the stock market to grow our retirement. But no matter what happens in the economy, debt interest is a sure thing. My in-laws situation? They had an awesome retirement, and right in the middle of the recession was their 5 year window, when they should have taken money out of higher yield/risk options of the 401k and put everything into a more slower growth, lower risk option. We tried to get them not too, but they pulled everything out in the dive. Now even with the match and 20+ years of accrued interest they lost money, but their debt interest miraculously was not affected! So they are still in the same debt with the same egg they had in the beginning, and they are, as I would be, scared a little. If they had stopped just for a bit on their 401k, they could have wiped out the debt, and even if they had taken their money out at the same time they could be rockin’ on retirement. Now it’s a slow go. I know it’s easy for everyone (me) to say,”Oh, I wouldn’t have done that….” but we have to remember the time. Lots of people were scared, and no one knew the future. A blank slate (debt free) or a home has added value in times of uncertainty.
I personally would not quit putting money into the 401 plan. Basically because that is money that is not taxed. If you decide to take the money on your paycheck you will be taxed for it. Therefore you will only be receiving about half of the money that you were putting into your 401 plan. My husband’s employer matches a pretty high percentage too. There is no way I would give up our 401 contributions in order to save money for a house.
You definitely need to do the 401k IMO. Most companies match a percentage…plus the tax benefits. What happens if you NEVER reach your goal? Say you go for 3 years paying off debt…and bam….a fender bender happens, someone breaks and arm….and then a computer breaks (just some little examples) guess what $500-$1000k deductible..insurance deductible and $500 for a computer then puts your BACK IN DEBT 🙂 If you have 5%-10% of your check put towards 401k ITS ALWAYS GOING TO SAVINGS….and with the stock market being sooooo bad, you’ll be glad that in 5-10 years when it’s hopefully rebounding, your money gained during that time 🙂 DONT STOP THE 401K…EVER, and DONT withdrawal from it either
I hate to say it, but I don’t agree you Jesse. 🙂 Sorry. Those years you are not putting money into the 401 K is losing money. I am sure someone else already explained it though. I just scrolled up and saw what Michele @ Saving Money put. That is SOLID advice. I 1000% agree with what she said. If a person starts contributing to their 401K later in life, they are losing all those years of interest accruing. Playing catch up is difficult and can be almost financially be impossible for anyone to catch up. Now listen, I owe tons of debt (hence the reason for my blog). However, there is no way we can WAIT to save for retirement after all of our debt is paid off. When I go back to work let’s say in 2-3 years, it will take me less than 2 years to pay off all of our student loans once I work full time but in the mean time I am still contributing. Jesse or Crystal, I really think you should add Michele’s post to your actual blog post so people can see that alternative.
Hi, Crystal (great name!) — I realized that some people misread Jesse’s post to mean we think you should always delay retirement saving to pay off debt. If you’ll read the post carefully, you’ll see that we think you should only do that very short-term in certain cases when it would actually end up getting you more ahead in the long-run. Those cases are likely pretty rare, but we believe they do exist.
I hope that clarifies it more! Jesse’s certainly not advocating that everyone who owes any debt should run out and stop their retirement savings today!
@Crystal,
Oh, I see that now! Sorry! My mind is scattered with kids today. Thanks for clearing that up. Yes, now what you are saying makes more sense. I can see why someone would do that short term.
@Crystal,
Oh, forgot to add, nice name too! LOL. I know A LOT of Crystal bloggers. 🙂 It must be our thing.
Definitely agree with the advice on an emergency fund. When we got married, that was the first thing we set back money for. One of the best things we’ve ever done!!
As an accountant, the fact that so many people rely on Dave Ramsey’s financial advice astounds me. His advice is not the best financial advice, in fact a lot of it is totally backwards, but designed for people who need to play mind games with themselves. I guess if that is the only way you can begin to get your financial house in order, then ok, but if you don’t need that then realize that he is out to make money and his plans do not maximize your financial means.
Well, thanks in part to Dave, we have a paid-for house, no debt, a good emergency fund, a plan for our children’s college and retirement and a good income. We’re able to give generously, too! His advice might not work for everyone, but it’s certainly made a huge impact in a good direction in our lives — and many, many others we know!
@Crystal,
I don’t mean this offensively, but I do want to comment on a few things people said.
As I said before, some people need these types of games to make it work for them. Thanks in part to common sense and a lot of hard work we put ourselves through college up to the PHD level; with no trust fund, college savings (we come from a super poor background) or family input. We have no debt other than our house, are childless by choice so do not need funds for anyone else’s college, give generously to charity, and have well over a 6 figure retirement in our early to mid 30’s. In our early marriage we owned our house/car and made $750 per month-we’re not priveleged people who fell into our current blessed situation. God blessed us and we worked hard to make the most of everything he gave us.
I am not dissing the fact that some people want to use Dave Ramsey, I am remarking on the fact that I wish more people would use their own common sense and money sense in general, and also that he is a business out to make money for himself. I applaud those of you who are completely debt free, but realize that having absolutely no mortgage and not using credit cards is not necessarily a smart thing to do in ALL situations, for SOME it might be. Having a small mortgage (with enough in investments, making more than my mortgage interest rate, to pay it off immediately if necessary) allows us to drop down a tax bracket for the IRS. In addition, if someone pays rent for awhile while saving up money for a house, they are essentially throwing away money that could have become principle on the loan. Again, I’m not talking about all situations, but I feel that some people wanted to tag me as judgmental, while judging me and deeming their own behavior as financially on the spot, when I would say it isn’t. As one poster pointed out, some people cannot remember to pay off their credit card every month…well, I would say that’s financial irresponsibility IF that was their goal AND they failed to do it because they forgot. They also miss out on float, and potential rewards from their cc. I always pay off my balance, put EVERYTHING on my cc, and have received almost $500 in cash back over the last year. Again, it’s not for everyone, but I think if a business (Dave Ramsey) tells you the only way to go is to get rid of credit cards, then they are giving bad financial advice. Again, it is never one size fits all, and I applaud those of you who have gotten out of debt, set your own particular goal to buy a house without a mortgage and succeeded in it, and other financial successes. I would however say that basic common sense and a little bit of free research could educate a person more about good financial practices than paying a business to sell you their merchandise in the quest to be financially sound. I’m not judging, I thought some people might want to know what a professional CPA thinks since it is in the realm of what I do day to day. Just my $.02.
Just to clarify: I think the biggest thing we’ve gleaned from Dave Ramsey is motivation and inspiration. He’s challenged us to think outside the box, to dream big dreams, to set big goals, to not be content with mediocrity and to see our money as a tool we can use to impact the world in powerful ways.
So while we don’t agree with him on everything and we don’t follow his advice to a tee (nor do we feel that anyone else needs to as we all have our own unique financial situations to consider), we are incredibly grateful for how he has inspired and influenced us to be radical and counter-cultural and to do what we likely would have felt was otherwise impossible!
@Tracey, Tracey, I think your opinion is a little bit judgmental. A lot of people need simple, hard and fast rules to live their financial lives by. That is what Dave offers and he simplifies things to make it easier for people to understand and follow. For some, if you say “You can use a credit card but only if you pay it off by the 28th every month” they cannot do that because they don’t make it a priority. They try but they slip and forget and life gets hectic with other more pressing matters like work and family. If you have the disciple and self-control to do things differently and it makes more financial sense, more power to you. Just don’t judge those who can’t or weren’t brought up with the tools to equip them to do so.
@Tracey, Thousands of others, including myself, are incredibly grateful for Dave Ramsey. My husband and I are in our early 30s and are almost 100% debt free, yes, including the house!! His advice is much like the advice given by Larry Burkett years ago. If you look at all the success stories, maybe that would help you to understand!
@Tracey, Thanks to Dave’s plan and motivation we paid off $23,000 in debt in 12 months with a $70,000 gross annual income.
I agree with Tracey that Dave’s advice is not the best financial advice, but for a society with so much debt, I think it helps a lot of people. After I read total money makeover we paid off my husband’s student loan but once I really thought about it I realized financially that was not the best move for us. I think Dave gives a simplified plan that helps people stay on target. For a lot of people if that is what it takes to get out of debt, great. In terms of maximizing returns it may not be the best. Of course as in Crystal’s case the idea of realizing you do not need to get into debt in the first place is huge, especially for the home mortgage that people assume is necessary!! I would love to have started living debt free, but we just did not think that way. I have always been good with money, but no mortgage that is a great idea. We would have been in better shape had we just rented a small apartment, then bought a house right away (all that money lost 🙁 ). I think opinions are going to vary more once a person is trying to get out of debt. Bottom line- Live below your means.
Thanks for the great advice, Jesse! (And from all who commented!). It is good to hear different opinions-now you can see why it is such a hard decision!
I really think we are going to tackle at least the consumer debt and the cars first, then when all we have is the mortgage and student loans (wihich is around 12k with 6% interest) we will start contributing.
Our credit card debt and two car payments is such a burden on our lives and we want to be free of those asap. We have made so many financial mistakes in our marriage, and now that we have taken steps to dig ourselves out, we are paranoid of making another bad choice.
One more factor to consider that I didn’t see mentioned earlier is that when you forgo contributing to your 401(k) you miss the opportunity to make that year’s contributions and you will never get that opportunity back. For example (and for simplification purposes, we’ll ignore interest), if you are 30 and wish to have $200K saved up for retirement by the time you are 50 then you can put $10K into your 401(k) per year for 20 years. But if you wait until you are 40 to start, you would need to put $20K into your 401(k) to get to the same amount when you are 50. The problem is by law, you cannot put $20K into your account per year (current max is $16.5), and you can’t go back and say, “well I didn’t contribute anything from ages 30 until 39. Once the year is gone, the opportunity is gone.
Of course there are other places to contribute to retirement, but they might not give you the same benefits that a 401(k) does.
@Michele @ Saving Money In Real Life, Great point, Michele. I don’t think that many people think about that. There are other retirement accounts you can open but there are certainly annual limitations on them too, such as Roth 401(k)s.
Every family is different and you need to do what is best for YOUR family, what works well for some of us doesn’t work well for the rest of us. With that being said I would encourage you (as have a lot of other contributors) to look at the following:
Employer match – If you are getting a match I would suggest you put in at least enough to get that money since it is a guarantee return on your investment, even if there isn’t a lot of interest made.
Your age – There is a difference between someone who by the end of their twenties (who also has a career that typically earns a better than average salary) could start saving for retirement versus someone who won’t be able to start saving for their retirement until their late thirties. Unfortunately I don’t think those of us who have a way to go yet before retirement will be able to rely on Social Security so the retirement money you save may be the only money you’ll have to live on.
Prepare for the unexpected – sometime lifes works out according to plan and sometimes it doesn’t. What if there is a job loss or some kind of catastrophe that would prohibit you making the kind of income you are expecting to make? It may work out that you would be able to start saving in five years but what if it doesn’t?
Is there something else you can do? – One thing that I’m doing this year is adding more money to my emergency savings because I’m worried about my job. However, if in a year or two things have stabilized and I have more than I need in our emergency fund I may pull from my savings to pay off the balance of our debt. Setting the money aside in a savings may not help you with the immediate cost of interst on your debt but it also helps prepare for the unexpected. I’m all for paying down debt, in fact my husband and I are working to pay ours down now and I talk about how we’re doing against our goal in my monthly financial updates over at my blog.
Is there another way that you could earn additional money to help pay down debt and save for retirement? Sometimes we get stuck in our paradigms of what we are already doing. I’m not sure if you work outside the home or are a SAHM, however is there another way to earn some money without to much of a sacrifice. Some ideas would be crafting, cleaning homes, freezer cooking for your friends who do work and don’t have a lot of time for homecooked meals, a weekend job when your husband can stay home with the kids. Sometimes thinking about a problem differently could give you a better solution.
Good luck – deciding what the best thing is for your family can be a difficult job. Just be sure to get information from several different sources and then make the decision that works best for you =:)
My husband works in retirement accounts for a large firm and the more you invest now the more you will have in retirement.
Before you cut your 401K contributions, think about what else you can cut?
Can you become a one car family? What about getting rid of cable? Can you eat out less? What about reducing your electric usage?
How much would you be contributing per pay check? If you are only contributing 20 or 40 bucks a month but still eating out, to me, you should cut other expenses first. If you are contributing a few hundred dollars a month then I would scale back to what your company matches or 2 to 4 percent.
Also stop contributing to your kids college funds (if you are?) it is more of a gift to your children to not have to support you in retirement then it is to get a free education.
To have nothing saved and to be so close to 40 is a scary thing. I would worry that if you wait there will always be “something” that will be in the way of you and retirement.
Oh and if one of you is a stay at home parent, remember that you need to save for the two of you, not just the working parent.
@Nora@ The Dollar Hollering Homemaker, “I would worry that if you wait there will always be “something” that will be in the way of you and retirement.” I agree totally with this statement. Once the debt is gone, it’s very possible there will be another reason that Alysia feels the need to tackle before funding retirement – needing a replacement vehicle, wanting a larger home, more expenses as her children get older, etc… I say start now by contributing something – and then gradually increase each year or every other year if possible.
@Natalie, I agree 100% with that statement as well. I have heard a lot of the financial experts say it is ok to stop funding your retirement to get out of debt but think about how you got into it in the first place: lack of self control. Hopefully you can overcome that on your path to financial fitness but I am sure that not everyone can! Better to put away some money for retirement that will reduce your tax burden and (heaven forbid) be protected in case you have to file bankruptcy.
@Nora@ The Dollar Hollering Homemaker, I’m with Natalie on this! You make such a good point, Nora. We are a one income and one car family, we specifically chose to buy our apartment so my husband could walk to the train station to get to work. We are doing everything possible to avoid a second car in the near future. We are temporarily stopping our contributions for a year (ONLY) to build up our emergency fund. We had a close call with my husband’s job and really felt the heat when we worried what we would do if he couldn’t find another job immediately. We only had enough in savings to cover ONE MONTH OF EXPENSES! Talk about dumb! We felt it was a safer use of our money in the immediate future to sock it away for a solid 6 month emergency fund rather than contribute to the 401K. We’d love to have 1 full year of savings, but that will take a bit more time.
Great input, Nora! Thanks for sharing!
I recently posed the same question to my husband. We read total money makeover and continue to tackle our debt. We have my 6k 2.4% variable student loan, 12k relative loan for house down payment 2.5%-what were we thinking, and 171k mortgage at 4.625%. We live in NJ 8k real estate taxes and high home prices, ugh! We have paid down 1/2 of our 345k home in 5 yrs but I am at a point were I am not sure what to do. The extra against the mortgage really does not decrease the term by much or the interest at this point. We really just need put a significant amount against the principle to see much of a dent but where to take the extra money from? I want to pay off the relative loan because even though it is not a problem and a low rate, it bothers me that we ever borrowed it. I have always been frugal but at that point in my life I just assumed everyone had a mortgage. Man have I revised my thinking. We just paid off my husband’s student loan 5k at 3.41%. It would have made more sense to put the money against the mortgage but after reading the book I had the mindset of attacking the smallest debts first and the interest rate is close to the mortgage rate, especially since the tax deduction was being phased out. We think we could have the relative loan paid off in 4 months but maybe we should put the money to the mortgage with a higher rate, and higher balance. I am so impatient to get our mortgage paid off so I considered decreasing our retirement contributions. Right now I do the max for the 401k (no employer match), my husband does a % and we contribute the max to our Roth accounts. I am 29, he is 31 and we had our first child in 2009, so alittle less $ to put against debt with daycare, maternity leave and 4k health insurance.
I would never stop contributing to my 401k entirely as it helps reduce payroll taxes and reportable income. You have to weigh the investment amount vs out of pocket amount.
Anyway I am just at a point where I do not know what to do. At first paying down the mortgage was so gratifying and we were full force, since the interest savings and lower terms kept us motivated, but now I just do not know if that is the best way to handle it. With the current extra we put to the mortgage we still have 5 years left :(. In some ways I just do not feel like we are making much progress. I do not want to increase our standard of living, but I feel like I have lost focus. Any advice?
@Kelly, Do you mean you borrowed $12k from a relative for your downpayment? I would get rid of that ASAP. If a relative borrowed that amount from me and paid off a huge debt (i.e. mortgage) before returning my money, I would be livid.
My husband actually borrowed the $ for his percent of our down payment. We pay interest on the loan. We were paying 3.5% but once interest rates dropped she lowered it to 2.5%, meaning she can increase it back as well. She acts as a bank for other family members as well if she thinks you are credit worthy. From her perspective she gets a higher rate of return then if it was kept in a cd so I am more worried that she will be upset when we pay it off. I do not want to pay it off unexpectedly and then she is wondering where to get a comparable return. She actually held the whole mortgage on her son’s house which he recently just paid off so lending to family is typical and beneficial for her.
One concern I didn’t see anyone address is how good of an investment is it to be putting money in a 401k at all. I know saving for retirement is necessary, but I know that several years in a row, I lost money (and my employer did not match anything), so I finally just put it in IRA CDs, because I am not going to scrimp retirement savings to have it lost to the market!
@Amanda Y., Excellent point! It is theoretically possible to lose all of your retirement savings if you put all of your eggs in the 401k basket. Or, if you have the bad misfortune of needing/planning to retire around the time a recession hits, you could wind up working longer if your 401k tanks (assuming you can stay at your job or find something else).
That being said, it is very important to see a 401k as a long-term investment. There will be years when a 401k loses dollar value, but the good thing is that you still own the shares. Over 40 years, those shares should increase in value significantly (anywhere from 8 to 10 percent annually, depending on what statistics you use).
@Amanda Y., @Amanda Y., As @Amanda Y. says, many people lost money in the stock market in recent years, but that is also why it is important to invest early in life and keep investing throughout your life.
The best way to describe it is many stocks are currently “on sale”. The value is low. So if you buy now, you can buy more shares for the money. In some years, when the market is high, you buy fewer shares for the money. Over the course of a lifetime, or one’s working years, it tends to average out.
If you lost money in the recent years, don’t pull out your money – keep buying. Just because you lost VALUE, doesn’t mean you lost MONEY. You still have the same number of shares. When the market comes back up, you will see your money continue to grow.
You only lose money if you pull out of the stock market completely – then you have realized your losses.
(Now if you were invested in a bad company, that is a different story. Most people should be invested in reputable market funds that diversify risk.)
Now is a terrific time to be investing in the market.
@Amanda Y., A 401(k) is not really an investment in an of itself but rather a vehicle for investing. A 401(k) does not mean stocks or bonds, necessarily. Usually there is an array of options to choose from for investing in your 401(k) which may include anything from agressive stock funds to conservative guaranteed investment funds.
@Michele @ Saving Money In Real Life, I understand what you’re saying, it depends on your company really. We never had an guaranteed options. One company I worked for let you choose from different portfolios, the other company only offered one for everyone–so if it’s not one well suited (aka losing money or high risk when you near retirement), it’s a bad place to have your money.
If you’re company matches your 401K you’re throwing away free money. I’d definitely say at minimum contribute that. With my company it is only three percent so I barely notice it out of my paycheck. If you and your husband were younger I might agree with the idea of suspending 401K contributions to pay down debt. But do you want to be working into your 70s? Compound interest is a powerful thing. Here is an example I pulled out from here (http://www.getrichslowly.org/blog/2008/04/02/the-extraordinary-power-of-compound-interest/)
For example, if 20-year-old Britney makes a one-time $5,000 contribution to her Roth IRA and earns an average 8% annual return, and if she never touches the money, that $5,000 will grow to $160,000 by the time she retires at age 65. But if she waits until she’s my age (39) to make her single investment, that $5,000 would only grow to $40,000. Time is the primary ingredient to the magic that is compounding.
Compounding can be made more powerful through regular investments. It’s great that a single $5,000 IRA contribution can grow to $160,000 in 45 years, but it’s even more exciting to see what happens when Britney makes saving a habit. If she contributes $5,000 annually to her Roth IRA for 45 years, and if she leaves the money to earn an average 8% return, her retirement savings will total over $1.93 million. A golden nest egg indeed! She will have more than eight times the amount she contributed. This is the power of compound returns.
@Sara, Averaging 8% is a VERY LARGE IF nowadays, so realistically it may not be the best use of funds is my honest opinion.
@Sara, ugh *your. Sorry, can’t believe I did that. It is a my pet peeve. An 8 percent return on investment really isn’t that high. The market is cyclical. Your investments may have taken a hit a bit there during the recession but they should be doing very well right now if you have a good portfolio
(or you might want to look at changing your investments.) I haven’t touched my. I am primarily in a life cycle Fidelity fund and have a a small portion in a some aggressive options since I am young. The last two years my portfolio is up 55 percent, portions of it are up 88 percent.
If the company matches contributions to a 401k, it would be foolish to at least put in that amount. Where else can you have an investment immediately double in value?
While Jesse’s answer addressed what he and Crystal did- it wasn’t exactly what they would do “if you were in our shoes” because we know nothing of Alysia’s financial situation other than debt exists. Will she and her husband have the means to max out retirement contributions in later years? If not, then it is imperative that they put something toward retirement now. Will the house be fully paid for by the time they retire? If not, then a higher retirement income will be needed to continue paying those costs. There are a lot of unknowns here that make answering this question in a meaningful way much more complicated.
We are on baby step 2 (paying down debt) and we are still contributing to 401K. We stopped contributing for a year, but then started contributing again because the company matches it up to 4%. We are in year 2 of paying down debt, and have 1-2 more years to go, and then the emergency fund to get in place. We are in our mid and I don’t feel comfortable waiting until we are 40 to start contributing to 401K. But, that’s just what we are doing 🙂
Rule #1 – ALWAYS pay yourself first!!!!
As a former accountant (now SAHM), I really like reading the “Ask Jesse” columns. I don’t always agree with him, but it’s interesting to see what the “numbers nerd” in your family thinks about some of the tougher aspects of personal finances.
Good article-it’s also worth pointing out that compound interest is like non existent these days.
I am so psyched for this column!
My husband and I decided to stop contributing to our 401K cold turkey until we have built up a sizeable emergency fund of $20K. Nothing is getting in our way, we’re getting radical.
Most people recommend that if your company matches anything, do up to that amount as it is free money. But we cut everything until our liquid emergency fund is ready to go.
@Ammie @ domesticallyobsessed.com, I’m confused as to why your $20K emergency fund is your only concern? Wouldn’t it be easier in the long run to have an emergency fund as well as a substaintable retirement fund?
I may have a different view considering I’m single, don’t own a house, have a paid off car… but, as I see it, $20K in a savings account will never become anything more. Additionally, what $20K can buy you now will certainly change in the future.
I’ve heard an appropriate emergency fund is a 3 month budget. Is that your standard as well?
@Allison, *substantial. I guess I was trying to make up a new word!
@Allison, Hi Allison-We own a home and a car and we are doing $20K to cover 6 months of expenses. While 3 months is a safe bet, 6 months is a much safer bet when your husband is your only source of income and health insurance.
While, yes, your retirment obviously is going to gain compound interest, without a solid liquid fund, we feel we are running into hot water should something happen to my husband’s job. We felt it was best in our situation to stop everything TEMPORARILY for one year until we have our 6 months of liquid emergency funds, and then redo our contributions. We already have close to $60K in retirment funds that has plenty of years to gain compound interest in the next 30-35 years, we just felt one year of not contributing will not do that much damage. I could be wrong, but again, this was what we felt was best for our situation.
Hope that clarifies. 🙂
My husband’s company matches his 401k contribution. My husband is 40, but we have a lot of debt. My husband puts his part in the 401k AFTER tax. His company matches. Every 3 months or so he pulls out ONLY the money he put in and pays down debt. The matching money and interest on the money he had put in is still there. Sometimes there is a small penalty to pay because of the way the 401k company pulls out the money, but time and time again we are coming out FAR ahead doing this. It is tricky and a pain, but we get the companies match and get to pay down debt. We have a failed business so we have had a significant amount of debt and YEARS of paying down debt, but this has worked for us.
@Lisa G,
Your DH must have Roth option in his 401 which a lot of employeers don’t offer. It’s great that it works for you, but I doubt it’s an option for too many folks.
@chris, Actually it’s a regular 401k, not a roth. He works for a mega corp that is nation wide so maybe that makes a difference. He just had to ask. A coworker did this to pay cash for his house and told my husband. It probably it not common, but it never hurts to try!
@Lisa G,
We have an after tax 401k option on my husbands 401k too. It is not a roth it is contributions made after tax that allows you to get in it anytime and taxes are paid already so it is tax free. I wish my husband’s international company matched it instead of just the before tax portions.
I think it is important to save for retirement throughout your entire working life even if it seems a pretty paltry amount and even if you debt. I personally think it’s part of establishing good habits and vision toward the future. When I first started saving for retirement I have lots of debt and a small income. I left that job just a few months later and those contributions are still are pretty tiny sum nearly 15 years later (they have grown, but with couple of bear markets and only about $800 in total contributions it’s a small amount) When DH was laid off and we had a very finite budget I still contributed to my 403b (again sort of token amount). That’s different than retirement needs to be your primary focus or you need to start out saving a whole bunch or that I wouldn’t suspend my contributions if I thought it was the difference between being hungry and keeping the lights on. When we decided in earnest to get serious about getting out of debt (in are case just our mortgage) we decreased our contributions for awhile and while it might have caused us to be in debt a month or two longer for us it was more important to keep contributing (and in our case get DH’s employer’s match.
I’m sorry to say that I completely disagree with your opinion. I have some data that backs up my theory that starting early is the only way to ensure a decent retirement.
If you start investing $3,000/yr at age 25 and stop contributing at age 35 (10yrs at $3,000/yr = $30,000) and assume return is 11% yearly (conservative estime), by age 65, you will have $1,211,578. If you invest the same amount ($3,000/yr) starting at age 35 and ending at 65 (30yrs at $3,000/yr = $90,000) and assume the same 11% return per year, you will only have $629,901. By starting at 25 with only $58/week contribution, you invest $60,000 less of your own money yet DOUBLE your nest egg. And that’s if you STOP investing at 35!!
I was blessed with parents who knew the secret to a successful retirement is to start investing early! I was also blessed to be hired by a company that puts 10% of my salary into my 401k regardless of my contribution. I additionally contribute 8% of my salary. To put it into perspective, and to give you encouragment that you can do it too, I’m 23 yrs old, I have $35K in student loans (roughly $500/month payments), take home ~$3000/month, and am completely financially independent, while living in an expensive city.
In my opinion, DON’T DELAY!
@Allison, IMHO, 11 percent is not conservative at all. With the current economic slowdown and inflation poised to skyrocket, we use 9 percent in our calculations. Your example is still very much valid, of course, but the numbers work out differently.
@Andrea Q, Understood. But, the effect of time on investments is unarguable.
@Allison, Agreed!
@Allison, Assuming any kind of positive return is not conservative in the current economy and 11% is definitely far from conservative. If you can make out that well, great for you, but not realistic to expect those numbers!
@Amanda Y., Agreed. Allison, I think you have a super valid point, and it’s great that at such a young age you are so well put together! Lord knows all I did at 23 was, well, I can’t remember b/c I was probably drunk. Living in a very expensive city. So good for you for being soooooo well ahead of the game. But, I have to throw my two cents in here and say 11% in today’s economy is highly doubtful, but if you are making that kind of return, god BLESS you.
If your company matches a percentage I would at least do that because if you don’t you are missing out on that free money.
Lately I have been wondering if we should stop contributing to our retirement funds (we both contribute the maximum to our Roth IRA’s and I contribute 20% to my 401k at work. We are also saving for our first home and hope to put 50% down. The problem is we saved about $28,000 this year but then have to take out $10,000 for our Roth’s, leaving us with $18,000 to put into our house fund. A starter home in our area is $230,000 (small, 2 bedroom). At this rate it will take us 6 years just to save the 50% down. We are in our late 20’s but somewhat paranoid about planning for retirement, as our parents did not plan well for theirs.
@Amber,
I would definitely stop the Roth contributions until you have your down payment saved up!
@Amber, what you are putting away in your employer fund gets you two benefits, company match (I hope) AND income reduction (AKA tax savings). Cutting out your Roth’s until you hit that down payment goal would not kill your retirement goal completely. If you think about it, part of your retirement goals is usually having your home paid off. So this would put you halfway to that goal with MANY years left (our generation will probably have to work until age 75!!) to continue building your retirement fund. Also, that would be a very big expense off your plate when you retire!!
@Amber,
I would NOT stop investing in your Roth IRA. Let’s assume you are 28 years old and are going to stop investing in your IRA for the next 6 years – and then start investing again at the age of 34. If instead you would have invested $10,000 each year from 28 to 34 – that will make a difference of about $365,000 (at a 6% return) to your eventual Roth IRA balance (plus when you withdraw the $$ it will be tax free).
On the flip side if instead you take that $60,000 over the next 6 years and use that as a down payment on a house it will only save you about $62,000 in interest over the life of a 30 year mortgage (at 5.5%). And that is before taxes – so assume a 25% tax rate and your tax savings lost on that mortgage deduction from paying in cash versus having a mortgage is roughly $15,000 – so the net savings is $47,000.
To me the answer is obvious. I don’t understand the urge for such large downpayments on a house or to pay cash all together for it. Unless you are highly flush with cash or liquid assets it just does not make financial sense.
@Jen – this is so well said!
You have to consider the interest rates. If your debt is credit card at 19%, then I would pay that off first before investing in a 401K that “makes” 5%. Remember that there are no guarantees with the stock market. But if your debt is has less interest, maybe do both, especially if you have a company match.
If you choose not to invest in retirement now in favor of debt payoff, you could commit to paying extra into retirement funds once you start to make up for lost time.
@Heather, I completely agree!
It’s important to remember that the miracles of compound interest work with paying off debt as well. If you invest $1,000 in a 401k at 5% interest, in the long run, it’s exactly the same as paying off $1,000 of debt at 5% interest. If you used that money in the 401k, yes, your savings would be growing and compounding, but your debt would also be growing and compounding. If you paid off the debt with that $1,000, you’d be preventing lots of compounded debt and interest payments, but you’d be giving up the same amount of growth in your 401k. The most important thing is that you’re saving in some form.
@Maggie, this theory is true if there is no employer match…even if the employer only matches 1/2 that is 1500 @ 5% vs. what you save on $1000 debt @ 5%. I am in agreement with everyone here. IF you get any kind of employer match, you should do what you can to maximize that benefit and then focus whatever else you can on not just paying your debt, but also building a small e-fund. Having even a small cushion ($1000) means you won’t need to reach for that credit card you are trying to pay off, when the car breaks down. Then you should max out savings until you have your full fledged e-fund. Then your other goals.
@Maggie, Don’t forget also that contributions to a 401(k) reduce your tax burden so with all else being equal that factor favors 401(k) contributions more. And as Shantique said, the employer match is a huge factor to consider as well.
In my opinion, contributing to an employer matched savings vehicle is a definite must-do before anything else! When I worked, I had an employer match of 50 cents to the dollar, up to 5% of my gross annual salary. To disregard that would be throwing away a guarenteed 50% return! Why would anyone do that? In the beginning, the income I was making was minimal so, I invested 5% of my gross wage, then I would max out in a Roth IRA. As the years went on, I forfeited a raise per say. Rather than increase my take home pay I would increase the amount of my savings at work the same amount of my raise. It was only a short period of time that I was able to max out my retirement account contribution AND max out on my Roth IRA. I am grateful I did so for I was able to retire at the age of 46 to care for my mom in her home who would otherwise need a nursing home. I sold my home and cut out all unnecessary expenses. Between that and super-couponing, I am able to live off of a small amount of money a month, money which I had saved. Yes, I feel owning a home is important, and having an emergency fund is a definite must before purchasing a home. But, to have a solid foundation provides peace of mind and is nothing short of a process which requires patience. Altering the tried and true steps are not for everyone. I’m glad it worked out for Crystal and Jesse. Best wishes for prosperity in your future.
Iyou are getting a good match (mine is 12% match with a 6% contribution,) it could be very foolish to stop retirement savings to pay off debt or bulk up other savings. It’s too much $$$ to pass up, especially when you consider the ROI over a span of 30 years until retirement (in my case.)
Another issue to consider is the return on your savings. If the return on your savings is more than the interest you are accruing on your debt, it may be prudent to continue saving and pay down the debt at a slower rate. For example, our home mortgage is 15 years at 4.5%. My current 401K has returned 10% since inception in 2008. Although I recognize the value in being debt free, I’m not convinced that paying down the principle of my mortgage is the best option right now.
All of that being said, there is a lot to consider! There may or may not be a “right” answer to a lot of these questions. Sometimes you just have to make the best decision for you!
I think there is a happy medium. If your company’s plan matches (aka free money), you should save the minimum and find other areas to cut to pay down the debt. If your company doesn’t match, you may consider pushing back participation, but plan to up your contributions to make up for the savings loss.
Also, you should NEVER NEVER NEVER cash out or take a loan from your 401K plan for anything short of avoiding forclosure or bankruptcy. The taxes and penalties will kill you. If you take a loan and pay it back, you still have problems. The first being if you leave that job (or are laid off) you will need to pay back that money asap or they will take it from your balance and you will still incur taxes and fees. PLUS, while with a loan you are paying interest to yourself, you are using post-tax money to pay that loan. In reality you are paying taxes on each dollar twice (once when you are paid in the form of income tax and again when you take out that money at retirement).
Just my 2 cents.
@Laurie, Just to add onto this: you probably shouldn’t cash out a 401K to avoid foreclosure or bankruptcy either! Retirement savings are one of the few assets typically sheltered in bankruptcy proceedings. If you’re going bankrupt it’s unlikely that retirement savings will help you avoid bankruptcy and you’ll definitely need those funds after the bankruptcy.
If you are in your early 3os and put off saving money for retirement until 4 or 5 years, you will then be nearly 40. Starting retirement savings at age 40, while not the worst thing in the world, is a bit late. The main disadvantage is that you will not have enough time to let your retirement money experience the magic of compound interest. Personally, I would aim at both goals simultaneously. Look at your company’s 401(k) plan and find out if the company provides a matching program. If they match dollar for dollar for the first 3% or 6%, then try to aim to put that much into the plan. Reserve the rest for paying off your debt. Even if it takes an extra year to pay off your debt, you will be able to let your retirement money grow and compound. Also, contributions to your 401(k) reduces your taxable income so you will be paying less in taxes, which essentially frees up some money for your debt payback.
Of course, everyone’s financial situation has to be evaluated individually. If your debt has a 20% rate, I’d be more likely to pay that off as soon as possible than if the rate is 5%.
As an example, I am 43 and started contributing to my 401(k) at age 22 and contributed between 3% and 13% until I was 34 and then stopped. I now have $150K in the plan, thanks to compounding. I never made more than $60K and most of the time I was making in the $30K range.
Here is another consideration, that I believe A.S. mentioned above:
My husband’s company provides a generous employer match on his 401K: 75 cents on the dollar, up to 10% of his pay. So, an annual contribution of $5000 actually amounts to over $8500, for us. 🙂 7.5% guaranteed “interest,” if you will, is hard to ignore!
Though Dave Ramsey advises differently, we continued my husband’s retirement savings while progressing through the Total Money Makeover. It made our “makeover” a bit slower, but with steady progress we’ve moved to Baby Step 5 in just about three years. In addition, we’ve amassed a generous amount in retirement savings.
If there is an employer match involved, I think I’d try to get “radical” about every expense outside of the retirement savings. Since my husband’s very first job, we’ve always maxed out the amount necessary for an employer match (always at least 50% on the dollar up to 6% of income) and because we’ve never considered it “our money”, we have never missed it. 🙂
@A, Please remember that nothing is guaranteed with a 401K. You can lose it all, including the employer match, if the funds you choose tank. Over the long term, the stock market performs well, but you never know for sure.
@Andrea: there’s no guarantee in the housing market either. Or that these people won’t get back into credit card debit. Too many people have little to no $$ in retirement. Unless you fall victim to a Ponzi/Madoff schemen it’s difficult to lose ALL of one’s retirement money when the market rises and falls.
@Andrea Q, Remember, though, that 401(k) money does not necessarily equal stocks. Usually there is a wide array of options to choose from including bonds, mutual funds, guaranteed investments, etc.
@Michele @ Saving Money In Real Life,
Exactly, Michelle. Our money is diversified and mostly in mutual funds.
Of course “nothing in life is guaranteed.” However, we are hoping that some degree of planning pays off.
@Michele @ Saving Money In Real Life, You would be surprised how many people believe a 401k is a FDIC insured savings account (which is why I mentioned it)! Of course, there are a lot of people who don’t know the FDIC limits either.
If the market drops 50% tomorrow , who caress? I don’ t need my 401k money tomorrow and the market has not only always recovered , but it’s always exceeded its value before the crash .
You have to think long-term when investing for retirement! At retirement you want to have 1-2 years of living expenses in a stable place like bonds or even a savings account, the rest keep invested in mutual funds so that it can continue to grow .
I completely get what Jesse is trying to say about short term goals for your money that benefit you more in the long run than putting that money in a 401k, and I don’t at all mean to be critical about what is good intentioned advice. But from a purely financial perspective, saving to pay cash for a home at the expense of not contributing to your 401k is rarely the right advice. It makes sense ONLY if you are really talking about a very short term, perhaps a year or two, and ONLY if you have the income to make up what you have lost in time value. I think that Jesse was trying to alude to this, but I’m not sure that part will come through to most readers. Ironically, saving to pay cash for a home at the expense of putting money into retirement savings makes LESS sense the younger you are. The time value of money is incredibly powerful – far more powerful than the current low interest rate for mortgages, and that does not even included the tax benefits of having a mortagage (as opposed to consumer debt). Moreover, if your employer matches your contribution, as many do, you are walking away from 100% return on your money. If what you are doing is paying off high interest consumer debt such as credit cards, and if your employer does not match, then yes, you are better off doing that. But if you want to know what to do as far as saving for a purchase, even one as worthwhile as a home, please consult a CPA. Yes, there are real advantages from a motivational standpoint of seeing your house savings grow faster, and yes, there are times and circumstances where paying cash for a home makes sense, but from a financial perspective those situations are rare. Time value, time value, time value. You just can’t “make it back up” later. That’s a devastating mistake far too many people make.
@L., Thanks for your input! We would definitely agree with you. As I mentioned above, we would rarely advise one to stop funding retirement to save for a house unless you were going to be able to buy a house within a short timeframe and had a good income.
Good question and good response. It’s tough to say no to “free money”, when a company provides a match for 401(k) investing. I personally think that the only goal that is worth not investing in a 401(k) is to get out of debt. While paying for a house in cash is a noble goal, perhaps a small amount of that could be funneled towards 401(k) that do have the free match (although some companies/schools don’t provide that).
The compound interest factor is incredible. My husband and I stopped investing in our non-retirement portfolio 2 years ago to build a cash nest egg, which would allow me to stay home with our children (I am pregnant with our 1st child). In the past two years, our portfolio savings have grown substantially, even though we haven’t invested a dime into it.
@A.S., We’d definitely agree in that only in very rare cases it would be a wise move to stop funding one’s retirement while saving for a house. It was a radical move we decided to make, but we wouldn’t necessarily recommend it for many others.
My two cents: we still have debt but we’re putting money into my husband’s work 401k because they match up to 4% so that’s like getting free money! It definitely makes sense for us and what we feel like is best for us. I know not everyone has that perk but we want to take full advantage of it. We also put in a modest amount into a Roth 401k because we won’t have to pay taxes on that when we get it out and we can tap into it sooner. We are in our late 20’s and want to be debt-free but also have a nice chunk of retirement savings in 30 years.
We’ve stopped contributing to our retirement except what my employer matches in the short-term to pay off our debt. However, we will be done in less than 2 years. I highly recommend reading The Total Money Makeover by Dave Ramsey. He discusses “gazelle intensity” and minimal budgets to pay off your debt as fast as you possibly can – perhaps you can pay it off quicker than 5 years, and then you’ll feel better about when you can start saving for retirement.
I think it would be wise to look at how much you will spend on interest for your debt, compared to how much you will make on interest if you keep investing. If you’re losing more overall by spending more than you stand to make, then I would pay off the debt first. But 5 years is a while to wait, so maybe pay as much as you possibly can this year and then re-evaluate the issue next year. (just an opinion) 🙂
@Crystal, Very much agreed!