Should I Stop Contributing To My 401(k)?

As one of the most common retirement savings vehicles, for many people a 401(k) is an essential component of building a nest egg for long-term personal finance security. Your 401(k) can help you save for retirement by offering tax advantages and potentially employer-matching contributions, making it a powerful investment vehicle.

But when folks need to make ends meet, unfortunately, retirement savings are often the first to go. Given our current economic climate, many might consider pausing their 401(k) contributions as they reevaluate their financial decisions. There are, however, some pitfalls to this strategy.

This article will help you evaluate whether or not pausing your 401(k) contributions is the smartest money move for your personal situation.

Factors To Consider Before Pausing 401(k) Contributions

As tempting as it might be to forego future financial security in pursuit of today’s comfort, pausing your 401(k) contributions should really be a last resort. That’s one reason it’s crucial to have an emergency fund in place — having accessible spare cash around when life’s surprises inevitably show up may mean you have less reason to rob yourself of potential retirement savings.

As any financial advisor will tell you, the thing about a 401(k) — or any retirement plan, for that matter — is that it’s all about long-term investing. Compound interest works best when ample amounts of time are added into the equation, so it’s a good idea to contribute to your retirement fund early and often. It’s also a smart move to avoid cashing out your retirement savings unless you have no other options.

Indicators That it is Time to Pause 401(k) Contributions

Now that we got that caveat out of the way, there are some scenarios in which pausing your 401(k) contributions, or at least lowering the amount you’re contributing, could actually be a smart money move.

While everyone’s personal finance situation is just that — personal — here are a few signs to look for that may mean it could be worthwhile to take a break from contributing to your 401(k):

• If your income drops with no decrease in expenses — for instance, if you get laid off, demoted, start a small business, or take a lower-paying job — it may make sense to stop contributing to your 401(k) for a while to cover any shortfall.
• If you have credit card debt, especially on cards with high-interest rates, pausing your 401(k) contributions to pay it off more quickly could actually help you increase your retirement savings in the long run. After all, the interest you’re funneling toward the credit card companies could be going into your own investment accounts to help your money grow.
• If you’re close to retirement and have already amassed a substantial nest egg, or are about to start taking distributions, you may not need to continue to contribute to your 401(k). After all, with such a short timeline, your rate of return is likely to be on the lower end.
• If your employer doesn’t offer matching contributions or suspends them, it’ll be less of a loss to pause your contributions, since you won’t miss out on what’s otherwise basically a free salary bump.
• If you don’t have an emergency fund and are at risk of losing your job, it might be more important to build up a safety cushion in the short term than plan for the long term, at least right now.

These are just a few of the signs that may prompt a contributor to reconsider their investment strategy — there are others to be aware of, too.

A big one: the IRS does place certain contribution limits on tax-incentivized retirement funds, and if you near those limits, you could face steep penalties for over-contributing. As a saver, it’s your responsibility to understand how much is going into your savings account — and what you need to do to keep on track with your overall savings plan.

Reasons Why You Should Not Pause 401(k) Contributions

Just as there are a few good reasons to pause your 401(k) contributions, there are many reasons not to. Here are some signs that you should leave your retirement contribution percentage right where it is — or possibly even increase it.

1. If you have plenty of time until retirement:Now’s exactly the right time to contribute! If you’ve got a long work life ahead of you, you’ll benefit the most from compound interest, which can help your savings grow exponentially. Even just a few years or a few thousand dollars can make a big, big difference later down the line.Here’s an example. Say you invest $1,000 into your 401(k) account at age 20 and then contribute $250 per month every month until you’re 60 years old. At that time, assuming a very reasonable interest rate of 6%, you’d have some $474,571.61 in your account—and this is a pretty low-ball figure since you’d likely contribute more than that as your salary increased over time or if you started to work at a company that offered an employer match.Now pretend you invest that same $1,000, and the same $250 per month, at age 30. That ten-year delay slashes your nest egg in half: with the same interest rate, you’d only have $242,918.05 by your 60th birthday. (Psst: this phenomenon is exactly why the IRS allows older savers to make catch-up contributions, so they can try to make up for the lost time in the short term.)
2. If you want to maximize your portfolio:If you’re looking to retire with a plush nest egg, pausing your contributions is likely a bad plan. Whenever your contributions are on pause, you’re missing important investment opportunities and decreasing your overall growth potential.One relatively low-risk way to level up your retirement plan: dollar-cost averaging, which allows you to purchase smaller amounts of a given asset at regular intervals, rather than plunking down a bunch of cash to buy the assets all at once. Dollar-cost averaging also applies to 401(k) contributions, so you’ll want to keep contributing even during a market downturn.
3. If you like the idea of paying less in taxes:One of the coolest parts bout contributing to a traditional 401(k) plan is that any growth and earnings are tax-deferred—which means your contributions reduce your overall taxable income in the year they’re made. That can mean a much lower bill when it comes time to pay Uncle Sam in April.Contributing to a Roth account, on the other hand, still requires you to pay taxes today — but you get to withdraw those earnings tax-free come retirement.
4. If you’re spending less due to COVID-19 restrictions:For many people — or at least those who haven’t become addicted to grocery deliveries and takeout — the pandemic has led to a decrease in spending overall. Good news: that means you can funnel that extra cash toward your retirement fund.Even if you’re not spending less than usual, cutting back on non-essential expenses can help you increase contributions and ultimately lead to a more secure retirement. Foregoing one $20 meal out each week adds up to $80 a month, which could factor out to thousands later on down the line given the magic of compound interest.Just remember, investing is all about the long game. Even in the worst bear markets and stock market crashes, investors who held their ground lived to see serious turnarounds given enough time.

What To Do if Your Employer Cuts its 401(k) Match

If your employer offers a 401(k) match, that’s awesome; it basically means you’re getting free money. (A quick reminder on how this works: your employer will agree to match your contributions up to a certain amount, such as 4% of your salary. That means every contribution you make will be matched with employer money, up to that percentage. It’s essentially a free raise.)

That said, if your employer cuts their 401(k) match, it can be a setback for your retirement planning. However, there are steps you can take to mitigate the damage and still stay on track for a comfortable retirement.

Focus on Damage Control First

The first thing to do is to reassess your budget and financial goals. Create a plan to prioritize your expenses and identify areas where you can cut back. This might mean temporarily reducing contributions to your 401(k), but be careful not to make any rash or permanent decisions.

Consider Boosting Your Contributions

Even though your employer is no longer matching your contributions, you can still maximize your retirement savings by increasing your own contributions — though, of course, that will have an effect on how much money you have to spend each month.

Carefully analyze your budget and financial goals to determine how much you can afford to contribute. You can also reach out to your employer’s HR professional, or the custodian of your account, to learn how often you can change your contribution percentage.

Open up an IRA in Addition to Your 401(k)

Opening an IRA, or Individual Retirement Account, can also be a good option if your employer has cut its 401(k) match. The IRA can provide additional tax benefits and investment options that may not be available with an employer-sponsored account, like ETFs and mutual funds.

You could also choose to roll your old 401(k) over into an IRA, or to keep the two accounts separate and let them each grow on their own. A rollover makes it easier to see all of your retirement savings in one place.

You might also decide to roll your 401(k) over into a Roth IRA for further tax benefits, though pre-tax rollovers from 401(k) accounts to Roth accounts will be fully taxable.

Bottom Line

Pausing your 401(k) contributions may be a tempting move to make during times of economic uncertainty or personal hardships, but given what it can do to your retirement funds, doing so should be a last resort.

Before making any decisions, it’s best to take ample time to assess your financial situation, consider the long-term benefits of continuing your contributions, and consult with a trusted advisor if you’re not sure how to move forward. They can help you make the best decisions based on your unique circumstances.

Remember, making informed decisions based on your financial goals is crucial for a secure and comfortable retirement.

If you’re considering consolidating your old 401(k)s, Capitalize is a trusted partner that can help you find and move them into an account that works for you.

We’re standing by to help you get your retirement funds right where you want them.