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Stop making 401(k) contributions?
Question: Hi Chris - I'm 38 and there's a better than average chance that I won't make the next cut when my company has another layoff. I've always socked away 401k money since my 20's but think that now might be a good time to keep that money in cash to help provide even more cushion during a job search.
We currently have almost 3 months salary in the bank. My wife works part time and takes care of our 2 kids. Would it make sense for me to set aside the money that would normally go to the 401k, and then invest in a Roth IRA at the end of the year if I don't have to tap into it? We have no credit card debt - just a couple mortgages, a car loan and several monthly prescriptions. Thanks - Mike, Denver, CO
Answer: Your instincts are right. I would stop contributing to the 401(k) and stockpile more cash in an FDIC-insured account in anticipation of tough times. You don't want to take any risk with the savings for now. Another way to build up savings is to look at what debts can you eliminate. It reads as if you have a mortgage, second mortgage (either a home equity loan or line of credit) and a car loan. Can you get rid of the second mortgage? How about the car loan? Both?
The one caveat to this advice is if your company offers a match in the 401(k). Do you reduce your contributions to the match or just stop altogether? Normally, I would say cut to the match and that may still work for you. But if the odds are high that you'll be laid off soon I'd rather you focus on getting your household balance sheet in good shape to weather a job search. And, of course, it isn't an issue if the company doesn't match a portion of your retirement contributions..
Good luck.
About the author
Christopher Farrell is economics editor of Marketplace Money, a nationally syndicated one-hour weekly personal finance show produced by American Public Media.
Chris, if Mike does take the step you've suggested above, and is fortunate to keep his job through the end of this year, doesn't he also need to adjust his tax withholding? Otherwise, he has increased his taxable, take-home income, and will face a higher tax liability at the end of the year, correct?
I would consider two things:
1) You might want to continue contributing to the match (if there is one) anyway, depending on the plan rules. Let's say that your company match is 50%. You will come out ahead if you need to withdraw those funds, becauswe the penalty is only 10%. For example, let's say you contribute $3000 and get the match of $1500. If you need to take out $3000, then you'll get hit with income tax (which you would have been hit with anyway, if you didn't contribute) and a 10% penalty, which works out to $300. But your match was $1500, so the net gain is $1200.
2) Invest in a Roth IRA now. Remember that you can withdraw Roth IRA contributions (not earnings) whenever you want for whatever reason. So put your Roth IRA funds in a very safe money market account. You will protect principal, and still have the ability to withdraw your entire $5000 during the year if you need to.
Good luck.
