Debt can be an overwhelming burden that leaves many people struggling to find a way to relieve themselves from the stress. One option that is often posed is to stop contributing to your 401k for the purposes of paying off debt. However, this course of action is complicated and deciding if this is the best option for you requires some consideration. Here are the key things to consider before stopping your 401F contributions.
What is your 401k company policy?
This is an important consideration because if your company matches your 401k contributions then there is incentive to continue contributing. This is basically free money from your company and it’s not uncommon for companies to match up to 6% meaning that you should do what you can to make the most out of your company’s contributions. How it works is that, for some companies, for every $1 you put towards your 401k, the company will pay an additional $0.50 to a point. Once you’re putting 6% of your annual salary towards your 401k then every additional dollar is on you. This is a great opportunity to make significant contributions to your 401k so check with your employer and see what kind of contribution incentives are provided, if any. If there are no incentives, then stopping your 401k contribution to pay off debt might be an option for you.
What kind of debt do you have?
The kind of debt you have really matters when it comes to tackling the problem. Student loan debt? Mortgage debt? Credit card debt? Medical debt? A combination of them? When it comes to paying down debt you’ll want to tackle the debt with the highest interest first. The interest rate matters a lot because that’s how you determine what to prioritize. My suggestion is to isolate what subset of debt you have that you can pay off and strategize a game plan to tackle the subset. However, if you’re barely making minimum payments on your debt, this can be tricky. You need to calculate how much money you need to target towards a debt, and for how long, before even considering stopping 401k contributions.
You may even consider lowering how much you put towards your 401K before stopping altogether. For example, if you are putting away 6% of your annual income towards your 401K, consider lowering that to 3% and using the difference to tackle down debt. Even if you’re only contributing 1% of your salary to your 401K that can help make a difference, especially if your employer matches your contributions. Lowering how much your put towards your 401K can help without stopping completely. Once you get your debt situation under control, then you can reevaluate and put more money into your 401K.
What are your long-term debt goals?
It’s important to evaluate what your debt looks like and consider how you came into debt to begin with. If you’re debt is from student loans or a mortgage the good news is that those are considered investments. Unless you plan to go back to school or buy a new home those debts are not going to remain fairly fixed, unless of course you consider refinancing them. However, debts from personal loans or credit card debts can be indicative or a larger spending problem that can grow over time.
Let’s say you have a credit card that you owe $5,000 on and work hard to pay that off, the only way to guarantee you won’t accumulate that debt again is to get on top of your spending habits. I would strongly encourage you to examine your spending habits before reallocating money from paying into your 401K to pay off your credit card debt. However, student loan debt is just as much of an investment as a 401K and paying down your student loan debt can alleviate your budget enough to put more money back into your 401K once the debt is paid off. When it comes to student loan debt, the investment of your education often increases over time as young professionals advance in their careers and their salary increases as well.
What kind of sacrifices are you willing to make?
Stopping contributions to your 401K to pay off debt should be the last line of defense towards financial freedom. So before you go down that path really consider if there are alternative ways to free up room in your budget. Can you consolidate debt? Can you spend less on on your bills? Is there a way to refinance some of your existing debt? I ask you to seriously reflect on your finances because your 401K will matter someday, even if you’re too young to consider retirement now. Where in your life are you willing to put in the financial sacrifice?
The fact of the matter is that if you can comfortably pay off debts while contributing to your 401K then you should put money towards both. Even if it means that your debts will be paid off at a slower rate, you are still setting aside money towards your retirement and that money will be important later in life. Ultimately this is a decision that only you can make and decide for yourself and any step towards financial freedom and security is helpful in the long run.