Why Contributing To Your 401(k) Should Come With A Warning Sign — A Tale From A Financial Counselor

By: Shelly Weber, Certified HUD Housing Counseling and Financial Coach

Woman Considering Her Budget And Employer Offered Retirement Contributions

We have often heard it said, “Do not neglect contributing to our employer’s sponsored retirement plan” — especially when they match 100% of our contributions. These are great returns! Little on Wall Street can bring us that kind of gain! However, contributing can come at a cost. It can jeopardize a working budget and lengthen the time it takes to pay down expensive debt.

Perhaps, taking advantage of an employer’s retirement savings should come with a warning sign: “Do not contribute until you are financially prepared.” This may sound counterintuitive, but let me explain.

As a Certified HUD-Counselor and Financial Coach for over 25 years, I have often witnessed consumers jumping into that pool of free matching funds too soon. Unfortunately, little time is spent considering how the consequences of a smaller paycheck would affect their overall financial health. Contributing too soon reduces the money that is available to pay off debts and to build an emergency savings. I remember counseling one couple who had recently retired. They had $60k in credit card debt; however, they were happy to report to me that they also had $60k in retirement savings. Of course, I was pleased with the growth of their retirement savings, but my heart ached at the apparent path they used to arrive at those savings: the use of credit cards. At this stage of their lives, they had little choice but to use their precious retirement savings to make the monthly payments on their accumulated debts. I wished I had had the opportunity to give them financial guidance years earlier. Please hear me. I realize life throws us all financial setbacks we could not have imagined; i.e., job lay-offs, medical bills, and even legal fees — but this is why it is so important to have a hefty savings for those unexpected expenses, which brings me to my main point.

When To Contribute To Your Employer’s Retirement Plan

When deciding when and how much to contribute to your employer’s retirement plan, you will first want to be certain of one thing; namely, that your emergency savings is in place. The savings should be enough to cover costs that may arise from the plethora of unforeseen expenses consumers often encounter. Whether a home or auto repair, a child or pet need, or even an unplanned trip, savings is the essential backup tool that needs to be established. I cannot stress the importance of this savings. A hefty emergency savings can do so much for you. It provides not only peace of mind, but also staves off the need to use credit, which means, you may even remain debt free! I also like to remind clients that retirement contributions should be money set aside that you do not need until you retire. In other words, you do not want to view your retirement savings as funds to pull from whenever you have unforeseen large expenses. This practice will only rob you of your retirement dreams. Likewise, 401(k)/403(b) loans may wreak more havoc on an already shaky cash flow by creating yet another monthly bill, which — sad to say — can then result in growing credit card debt.

You Need An Emergency Savings Account First Before Contributing To Retirement

I recall several of my clients who were struggling to pay off their credit cards and had little or no savings, but also tell me they had recently started or even upped their retirement contributions. Was I hearing them correctly? I recognize the emotional security that comes with a nest egg for our Golden Years, but please understand this growth may come at a cost. When is the time to jump into retirement savings? Not until you have an emergency savings account and a plan to reduce your consumer debt at a consistent clip. If you are unsure if your budget allows this, you can start with a minimum contribution; for example, 1-2% of your gross income to make certain that each month you can still work on building savings and reducing debts. 

Reviewing your monthly budget is also key in helping you determine when you will be ready; it will show you your monthly discretionary income, which you can funnel into your retirement investment portfolio. You can set a goal to increase your investment as your consumer debt decreases. Nobody wants to retire with $60K in consumer debt, the interest on that debt will outpace the growth of your portfolio.

Taking advantage of our employer’s retirement matching plan is a great investment. The focus should first be on growing emergency savings and getting consumer debts under control before over-feeding retirement accounts. This will help build a secure financial future.

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