When Not to Contribute to Your 401(k)

It is almost an automatic reaction to recommend to people that they should contribute to their company 401(k).  As is usually the case, however, it's not that simple.  Cliff Goldstein of Marketwatch has written a nice article entitled "5 Reasons Not to Contribute to Your 401(k)."

Here are his points with my observations in bold:

1. You don't have an emergency fund

The key is that you don't want to be forced into a situation where you have to borrow at high interest rates due to an unexpected expense.  If you do, then you negate earnings on 401(k) assets.  The size of the emergency fund is worth some analysis.  It depends on such things as the dependability of income, how old your house and car are, and even your health.  Bottom line:  first have an appropriate emergency fund before funding your 401(k).

2. Your employer doesn't match contributions

In just about every single case where an employer matches some portion of the employees contribution, it makes sense to contribute up to the match.  For example, if an employer matches 50% up to 6% of salary, then an employee should seek to make a 6% contribution. The employer match is effectively "free money."  If there is not match, then an IRA with a discount broker may be a better choice.  If one spouse has a match and the other doesn't, then it typically makes sense to be sure to take full advantage of the match.

3. You're swimming in debt

If you're paying high rates on debt and contributing to a 401(k), then you are effectively spinning your wheels.  Reducing your debt is a guaranteed return on money compared to an unknown return on investments.  This is especially the case for loans with rates exceeding 6%.

4. You fear future tax increases

In addition to Goldstein's points, consider that it makes sense to diversify retirement assets on a tax basis.  That is, it usually makes sense to have some assets on which you have already paid taxes along with tax deferred assets.  This gives you some flexibility in retirement in terms of which "bucket" you'll draw money from.

5. Lack of flexibility and high fees

All 401(k)s are not created equal.  In fact, some are horrendous.  They charge excessive fees and have poor choices.  Working married couples should look closely at their respective 401(k)s to see if one is superior and, then, use that to a greater extent if it makes sense.  Also, do a bit of analysis before rolling over a 401 (k) into a new employers 401(k).  Many times the better choice is to roll over into an IRA.