Stopping retirement contributions

[LivingAlmostLarge]

This is a serious question, why when people come here and ask about getting out of debt, someone always says stop your retirement contributions and get out of debt?

Here's my question to that statement. You always have to save for retirement. You have to get used to living on less than you make. Say you save 10% for retirement, if you keep using that 10% to pay off debt, build EF, etc, when do you get used to living on 90% of your income?

How do you get into the habit of budgeting on 90% of your income if you are using 100% to pay off debt?

Plus I always wonder, when you stop retirement contributions to pay off debt is it really worth it? I mean you are losing compounding, tax breaks, etc.

And have you really cut your budget? Are you not eating out? Not renting movies, watching cable, buying clothes, no car or home repairs, turned the heat down to 55, only using coupons to cook, etc?

I mean are has the budget really gone bare bones that it justifies stopping retirement contributions? I guess I sort of feel stopping retirement contributions to pay off debt is the easy way out. You don't necessarily change your lifestyle, you just alter it for awhile and use the extra money you shouldn't be using to get out of debt.

What's the reasoning behind it? I understand if you are in debt and not making ends meet, but otherwise?

[Inkstain82]

The reasoning is that the math is better. All psychological issues aside, the interest rates on your debts are likely higher than the return on your retirement.

[jIM_Ohio]

LAL-

I agree with you
The single most important aspect to financial success is spending less than you earn. Whether you carry debt or not is much further down the list, and not a contributing factor nearly as much as spending less than you earn.

If I were to write a book, it would preach the more you don't spend as a percentage of gross income, the more financial success you will have...

To me, if someone is not setting aside 20% of GROSS pay for retirement, short term savings or debt paydown, they are fighting an uphill battle.

A person can probably retire saving 10% of gross pay in a 401k like tax deferred plan.

However if the "attitude" is that when times are tough, that 10% is among the first things you "tap", I think retirement becomes a goal instead of a reality in many cases.

If you save 10% per year, it takes you 9 years of working to have saved 1 years worth of expenses.
If you save 20% per year, it takes you 4 years of working to have saved 1 year of expenses.

The latter greatly increases chances of success. And if you have to "tap" into 20% when times get tough, you are OK because you might not need to tap all of it, just some of it, to make ends meet.

[GREENBACK]

I don't thinki people give this enough thought. They are mired in debt and intuitively decide to throw every dollar at the debt. This isn't neccesarily the greatest move. Funding retirement is a long term process for most and the effects of compounding interest, tax breaks and matching employer contributions should be looked at before you decide to appease some banks demands about what you owe them.


All apologies to DR fans but owing money isn't neccesarily a bad thing. It depends on the individual circumstance. I'm certainly not stating that debt is a good thing but think about what moves you're making before you go the route of "throw every dime at it".

[fruitbowlk]

That is one think I didn't agree with when it came to DR plan. I didn't stop saving for Retirement when I was getting out of debt. But I also didn't have a whole lot of debt either.

[am_vanquish]

Originally Posted by Inkstain82

The reasoning is that the math is better. All psychological issues aside, the interest rates on your debts are likely higher than the return on your retirement.

This is EXACTLY right. The most rational answer is to do everything LAL said (cutting expenses, quit using CC's, etc.) AND snowball the debt, then return to retirement savings. If you do this, applying the 10% only to old debt & not acquiring new debt, then you're still only living off of 90% income (because the 10% doesn't go to CURRENT expenses).

Most CC interest rates are 20% or more for those struggling with debt. In an average economy (this year's returns are skewed thanks to mean-reversion), a typical retirement portfolio would struggle to return 20%. So why put money in a retirement account earning 8%-10% when you could pay down debt at 20%?

Unfortunately, we are not rational creatures. In fact, we are extremely irrational. Therefore, the most common scenario is that a person convinces themselves it's okay to stop retirement savings using the logic above ... but then doesn't execute the step where they stop acquiring new debt.

**The ONLY exception is employer matches (if available).

[LivingAlmostLarge]

It just seems like an easy out. Cut retirement = get out of debt. No suffering or sacrifice along the way.

[GREENBACK]

Honestly, I would rather handle a bit of debt while knowing that my retirement investments are solid. Screw the math. When you're 65 you'll find that all that clever math didn't add up if you don't have an adequate nest egg in place.

[disneysteve]

As I often suggest, why must everything be black or white? When I was swamped with student loan debt, I made large extra payments to retire those loans early. But I simultaneously invested for retirement and other goals. I did not, however, invest 10% toward retirement. I couldn't do everything at that point. Initially, I was investing 6% of take-home. I later changed it to 6% of gross. Then gradually increased that number as my income rose and my debts shrunk. Now that we are debt-free except our mortgage, I've gotten up to investing 21% of gross (and 50% of my wife's gross).

I could have paid off the debt even quicker had I not invested anything, but I think doing some of both was the best way to go.

[Daylily]

Originally Posted by LivingAlmostLarge

It just seems like an easy out. Cut retirement = get out of debt. No suffering or sacrifice along the way.

I guess I'm impressed that someone is saving for retirement at all. I'm more concerned about the person who doesn't even have the option of cutting retirement savings to get out of debt because he/she wasn't even contributing in the first place

[lovcom]

You stop the 401k contributions and kill the debt because 21% to 29% interest on debt is more then any tax, interest benefits the 401k can provide.

Do the math, and if you do, you will find it is exceedingly silly to continue the contributions when one has a lot of consumer (non mortgage) debt hanging around his neck and massive componded interest rates.

One can always restart the 401k contributions after the consumer debt is killed, and if you do the math, one comes out way ahead and with less vulnerability to job loss.

The way to go, and in this order of priority:

1. Build minimal emergency fund.
2. Kill the consumer debt, all of it.
3. Maximize the emergency fund.
4. Restart retirement contributions.
5. Go and "sin" no more.

You do it all at the same time, you extend the time it takes to reach your goals by many years, of not decades.

[watsoninc]

Originally Posted by LivingAlmostLarge

It just seems like an easy out. Cut retirement = get out of debt. No suffering or sacrifice along the way.

If you are intense about getting out of debt and can get out of debt within 18 to 24 months, suspending retirement investing may have the additional benefit of motivating you to get out of debt more quickly. When I snowballed my debt, I stopped investing. This was hard on me because I was just learning about the impact compounding interest had on long-term wealth-building. As a result of stopping my investing, I cut lifestyle very deeply so that I could return to the wealth-building & start having fun again. Now that I am debt-free (excluding mortgage) and married, we invest a huge percentage of our income. Overall, I don't think this was the easy way out at all, but it helped me achieve my very goal quickly.

[disneysteve]

Originally Posted by lovcom

You stop the 401k contributions and kill the debt because 21% to 29% interest on debt is more then any tax, interest benefits the 401k can provide.

The exception to this is a 401k match, since that amounts to 50% earnings. I'm sure nobody has a CC charging 50% interest. So I would go along with dropping contributions beyond what is needed to get the maximum match and putting all other available funds toward debt.

Something else to think about, though, is the tax issue. If you are in the 25% bracket, what you lose to taxes might outweigh what you save in interest depending on the rate on your debt.

[watsoninc]

What about the risk involved in staying in debt though? Universal default is scary, and I have unfortunately heard of credit cards with 79.9% interest. By playing with snakes, people are risking repos, late fees, high interest, along with other bad things. Isn't it better to get these snakes out of your life?

[LivingAlmostLarge]

DS, that's the thing with our tax bracket and federal and state income taxes we're looking at 33% taxes off the top if we stopped contributing. Not to mention the match. It'd be ridiculous to pass up a 100% return on investment with a match.

Are credit cards really 33% mostly? I thought most people fell into the 10-20% category?

[Broken Arrow]

Well, I'm mostly in the "Do what gives the most bang for the buck" camp. So, even though I am debt-free right now, that has never been my real goal. It just ended up that way, because my debts at the time were costing me more than anything else.

I did still maintain retirement contributions, because my previous employer offerd 28% contribution, and my current one is offering 50%. But once maxed, I move on to something else.

Another factor that's been touched on is risk. Risk from having debt and risk from certain types of investments. Risk of debt, for example, also affects risk on our monthly budgets, which is something else to think about....

Sorry I don't have clearer thoughts right now, but I'm also a bit preoccupied with work. But my point is that, in light of these factors (and more I can't think of right now), I end up doing a combination of things at any one time.

[Scanner]

It's all philosophical.

I can't remember the classic book (Maybe "Richest Man In Babylon"), but the philosophy of the book was "Pay yourself first."

The idea is, and it's true for the most part, you will always have some form of obligation to someone (debt) in your life. It's just something that comes along with you for the ride in life. If you wait until you are debt-free to invest, you will never invest.

I've invested at some of the most "leveraged" times in my life and never really regretted it. For instance, when I graduated chiropractic school, I had $53,000 in debt, a new mortgage and was starting a business. Yet, that year(s), I max out my wife's and my Roth IRA.

Do you know how golden of a decision that was?

What if I had done a "Dave Ramsey" and decided to just pour everything into debt reduction?

So, I do mostly agree with the mantra - "Pay Yourself First." In that, I may be kinda "anti-Dave Ramsey."

[LivingAlmostLarge]

I guess my take is if you are living on nothing, and have cut everything like cable, groceries, eating out, cell phones, then fine; do cut the retirement.

You are obviously serious about debt repayment. But otherwise? If you have luxuries in the budget, why are you cutting retirement instead of the luxuries?

[lovcom]

Originally Posted by disneysteve

The exception to this is a 401k match, since that amounts to 50% earnings. I'm sure nobody has a CC charging 50% interest. So I would go along with dropping contributions beyond what is needed to get the maximum match and putting all other available funds toward debt.

Something else to think about, though, is the tax issue. If you are in the 25% bracket, what you lose to taxes might outweigh what you save in interest depending on the rate on your debt.

Then the market goes south and one loses 50% value in their 401k, and thier massive consumer debt is no less decreased. Or worse, the market goes south, AND they get downsized out into the street...401k half gone, no job, and consumer debt is no less decreased.

I think getting to zero debt is a huge value even in it's concept, and getting there means one is less vulnerable to being downsized or fired..to me that is more valuable then the employer's contributions even if they're 50%.

I think sometimes one has to leave $$ on the table in the short run to get security for the long haul.

Of course I would not turn off 401k contributions for longer then 12-18 months, and for the reasons you stated.

[ceejay74]

This is a really interesting subject! I've kept putting a minimal amount (6%) into my 401(k), even when my employer stopped the matching program. I have my husband put the minimum needed to get his matching at work. And I put aside $120 per month for my partner who's currently unemployed, just because it feels really weird not to have her building retirement at all.

But I've considered whether I should up those contributions or not...By next month, I'll have eliminated another high-interest (8.99%) debt, and then my highest-interest debt will be a student loan that's at 6.8%. I still have a lot of debt but the rates are all low: 6.8%, 6.55%, 4.5%, 3.99%, 3.9%, 3.875%, 2.5%, 1.49%, 0%. Also, all but one are either mortgage or student loan, so they all have tax benefits associated.

At what point does the compound factor of retirement outpace the interest you pay on debt? Does that make sense? Or does the interest on debt compound negatively at the same rate? Can you tell I don't know what I'm talking about??