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When You Should Not Contribute to a 401(k)


All your life you've heard about the merits of saving for retirement in a 401(k) at work. You don't miss the money because it never hits your hands, you pump money into the investments regularly so you dollar cost average, and of course, if you're really lucky, your employer adds to your total with their contribution.

But, much as it may be hard to fathom the notion, there are some times when it might be best that you don't contribute to your company's 401(k), temporarily, or at all.

Here's when it's okay, to just say no.

You're deep in debt

Your mother probably told you, "first things first." She's right. Life is about priorities. Much as you want to start saving for retirement, truth is, if you're so deep in debt you're awake at night worrying about it and creditors are blowing up your phone, the wiser move is to pay down that debt before you start socking away money in your 401(k), or if you're already investing, suspend contributions for a time.

It's not an easy choice. Get help. "Decisions concerning whether to pay off current debt or contribute to a 401(k) should be discussed with a financial adviser," says Steven Shapiro, PhD., a New York Institute of Technology finance professor.

Is less more?

Before investing in a 401(k) you want to figure out if you can really afford to reduce your take-home pay by the contribution amount, after adjusting for the tax benefit, says David Altschuler, a certified financial planner.

Look at your monthly expenses. If you're having trouble meeting them, you may be better off not contributing, until you have a bit more wiggle room in your budget. Assess where you might make cuts in your budget to free yourself to contribute. The sooner you save for retirement, the better.

Are you prepared for the "what ifs"

Retirement is years away, but what about next month, three months from now or next year – the shorter term? If you should lose your job or get sick, would you have three to six months worth of emergency savings to keep you going? If the answer is no, re-consider saving in a 401(k) or reduce the amount you're contributing, until you accumulate an emergency fund.

"Should an emergency arise, money invested in a 401(k) is more difficult to access than money invested outside of one," says Aron Gottesman, professor of finance at Pace University's business school.

If you borrow from your 401(k) and leave the company, you'll have to repay the loan, or pay income taxes. Worse still, if you're younger than 59½, you'll have to deal with a 10% penalty tax on the remaining balance, plus ordinary income taxes.

You don't want to have tap your 401(k). If you borrow from your 401(k) and leave the company, you'll have to repay the loan, or pay income taxes. Worse still, if you're younger than 59½, you'll have to deal with a 10% penalty tax on the remaining balance, plus ordinary income taxes.

Fees, fees and more fees

Investigate just how much the plan charges in fees, including administrative, investment and management fees. If they are around 2%, think twice about investing. That amount is sufficient enough to ruin any real progress on the road to saving for retirement.

There's little choice

If the plan at work has really limited investment choices and there's not much in terms of diversity, it might be worth looking into contributing to an IRA instead, as you will have broader investment options, says Pam Capalad, a financial planning analyst with WealthEdge.

You've got retirement covered

You do not need to contribute to a 401(k) if you are in line to receive a substantial inheritance that is enough to sustain you when you quit working, says Charles Murphy, vice president and CFO at American Investment Services.

There is a caveat. "But, it depends on how certain that inheritance is, and how liquid," he adds.

Murphy says that those in the $1 million-plus salary club don't need to worry about 401(k)s either. "You can easily build up enough money to use in retirement without putting it into the stock market, using municipal bonds, tax exempt bonds, cash and private investments such as real estate."

What you've heard about the 401(k) is right, it's a great way to save, and quite frankly, without it, many people would have no retirement savings. So choosing not to contribute isn't a decision to be made without much thought. Says Vincent Barbera, partner and wealth manager with Newbridge Wealth Management, "The general theme is the 'redirection of monies'. To stop contributing to a 401(k) just to pocket the excess is not an option. The money needs to be redirected to a source that is more important and has a higher priority at the time."



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17 Comments.
Comment #1 by saverinCA posted on
saverinCA
I agree with everything but the last piece of advice:  "You do not need to contribute to a 401(k) if you are in line to receive a substantial inheritance that is enough to sustain you when you quit working, says Charles Murphy, vice president and CFO at American Investment Services."

This was my financial downfall.  My father set up an irrevocable trust fund for me that was decades old, worth over a million dollars, to be paid at his death. He set up one for my children and my brother and his children.  We received yearly statements about the holdings.  When he remarried late in life, his wife (whose daughter and son-in-law are lawyers and eventually became executors of his estate) took advantage of his onset of Alzheimer's and had the trusts dissolved completely.  Of course I took it to court, but what they did was legal.  I had spent my entire life under the impression that I would have the money in my older years, and I DID NOT SAVE.  So needless to say, when he died (I was 50 years old), I had to start over again with savings.  It's been a rough road.  So - please add the caveat that if you THINK you are going to inherit a lot of money to cover your retirement, SAVE ANYWAY!  

16
Comment #2 by Anonymous posted on
Anonymous
You are absolutely right.  What a let down that must have been for you and the  family. 

Your situation is not the first case where I heard of a parent loosing a spouse and marrying again late in life, with family trusts or wills being changed to suit the new spouse, leaving the children out. 

Even when a substantial inheritance does materialize, it never hurts to have accumulated savings too.  A person can never have too much money.  There are always other family members or charitable organizations, etc.,  to support. 

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Comment #4 by bbug posted on
bbug
I'd be interested in how an irrevocable trust can be revoked. Can you elaborate?

bbug

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Comment #5 by Anonymous posted on
Anonymous
Very good question! 

But when it comes to lawyers, almost anything is possible.  Particularly in this case:  "his wife (whose daughter and son-in-law are lawyers and eventually became executors of his estate)".

2
Comment #6 by paoli2 posted on
paoli2
#4  It sounds like they used his father's Alziehmers condition to prove he wasn't in his right mine when he made the trust.  However, if he did the Trust before his dementia set in (which it seems like he did from the post)  it is difficult to understand how they got it changed.
A word to all spouses if you have a child or children you want to leave an inheritance to, make sure you put as much as you can in POD accounts so that they can get it if the living spouse remarries.  Never, trust that the new spouse will see to it that "your" spawns will get what you want them to inherit especially if he or she has children of their own.  Money and/or property can make humans very greedy.

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Comment #7 by Anonymous posted on
Anonymous
As a general rule, no matter what the justification it can be done only with a court order - meaning, hiring a lawyer and paying fees. Also, depending on the jurisdiction, and assuming the case will be tried in a probate court, expect to wait a long time. Many probate courts are working on short weeks and are hopelessly understaffed. And, after all that, there is no guarantee that the court will actually allow the revocation - that will depend on how well your attorney can present your case.

2
Comment #14 by saverinCA posted on
saverinCA
It's been so long ago, I don't even remember  - but the trust funds were tied with his insurance policy.  When he started to exhibit signs of dementia, that's when his wife talked him into making her daughter and son-in-law (both lawyers) the executors of his estate. Before he was diagnosed with Alzheimer's (meaning before he had had tests and so forth long after the dementia presented itself at this point) , they had him dissolve the trusts and put everything in the wife's name. My lawyer did review all the details and said it was legal.  They were in Texas, if that makes any difference.

1
Comment #15 by bbug posted on
bbug
I empathize with your situation. But, if he could dissolve the trusts, the only thing I can surmise is that they were not irrevocable.

Here's some info from the web on trusts:
Another very basic classification of trusts is whether they are revocable or irrevocable. If the grantor reserves the right to revoke the trust after it becomes effective, including the right to change any of the terms or provisions of the trust, then the trust is said to be a "revocable trust." If the grantor gives up the right to revoke the trust after it becomes effective, including the right to change any of the terms or provisions of the trust, then the trust is said to be an "irrevocable trust." Before we go any further, it is important to note that this classification only applies to living trusts. A testamentary trust is always revocable during a testator's lifetime because a Last Will and Testament cannot become effective until after the testator's death and after it has been admitted to probate. Once a testator has died and his or her Last Will and Testament has been admitted to probate, the underlying testamentary trust becomes irrevocable because the only person who could revoke it or terminate it is no longer living. So, when we talk about revocable trusts and irrevocable trusts, we're not talking about testamentary trusts - we're only talking about living trusts.So, what's the difference between a revocable living trust and an irrevocable living trust? Well, to state the obvious once more, a revocable trust can be amended, revoked, terminated or changed at any time by the grantor. An irrevocable trust cannot be amended, revoked, terminated or changed by the grantor or anyone else once it becomes effective.

2
Comment #16 by saverinCA posted on
saverinCA
They were created as irrevocable.  That's why I never worried when he got remarried (twice).  I assumed they could never be revoked.  But they were, and my lawyer said it was all done legally.  I think I was in such shock at the time, I don't even remember all the particulars anymore, but I did keep all the documentation as to why it was legal, etc.  It was terrible enough that he died, but then on top of that to be told our trusts were gone was really a horrible experience.  

1
Comment #17 by bbug posted on
bbug
I'm at a loss, not a lawyer and I don't want to make you relive these bad memories, but. if it was me, I'd reexamine the documentation. I know you said you took it to court and lost. Perhaps you got poor legal representation but, even if you did, the Statute Of Limitations may make the exercise moot.

1
Comment #3 by rjcohen posted on
rjcohen
Your exceptions to making 401k contributions seem reasonable, except that once a tax year's retirement contribution opportunity is gone, it is gone forever.  Depending on one's combined Federal and State marginal tax bracket, the dollar you don't contribute to the 401k will shrink to 50 to 90 cents in your pocket.

In addition, you've not considered behavioral factors that prevent about half the population from saving anything significant for their retirement.  In many cases, that 50 to 90 cents will not end up being used to pay down debt or establish emergency reserves.

The readers on this site and blog are probably pretty good savers.  However, most people's spending magically expands to whatever is in their checking account, and in many cases, a little more debt on their credit cards or HELOC.  They need to make a habit of saving FIRST.

In addition to committing to 401k contributions, I've found it effective to have clients commit simultaneously to paying down debt and establishing the emergency reserve.  That makes them feel good on three different levels, even if saving at 1% rather than paying more debt down at 10% is not *optimal* from a financial planning standpoint. The magnitudes can be small at first, but at least they are heading in the right directions, and learning good habits.

Under the regs, employer 401k plans must offer ways to diversify your investments.  I've seen some shabby menus, but there's always some way to access stocks, bonds, and something with stable principal.

As for fees: it's a travesty when employers won't spend a nickel on the 401k plan, and the participants must pay fees of 2%+.  But given the average tenure at a given job, it could be worth the fees in order to get more invested than one would with an IRA on the side, since you'll be able to roll out of the 401k in a few years.  Some plans even allow for in-service roll out.

The recent introduction of Roth 401k accounts is great for those in low tax brackets, for whom the tax advantages of a regular 401k may not have felt compelling enough.  The Roth 401k is also useful for those who already have substantial tax-deferred assets, and want to complement that with tax-free assets to achieve tax diversification in retirement.

4
Comment #8 by decades posted on
decades
As for fees: it's a travesty when employers won't spend a nickel on the 401k plan, and the participants must pay fees of 2%+. 

I know , have half a million in my 401k and pay fees and loads of $11,250.00 a year. Also thier guaranteed fund is always about half what I can get from penfed cd's. One time I borrowed out the max from 401k and put them in penfeds 6.25% cd's . Now they have quarterly fees for when you have loans out . 401k plans are one of the biggest scams going . everyone benefits except the participants. 401k vendors come along and pitch these plans where they will do all the administering of the plan and in return get to offer these crappy loaded funds. the mutual fund companys benefit the 401k vendors benefit , and the employers benefit from not having to offer a pension plan .

5
Comment #9 by Anonymous posted on
Anonymous
Not all 401Ks are the same.  That's the highest plan costs I have ever seen.  Even so, if 2% fee and loads totaling $11,250, are taken out, that means that person had at least $562,500.00 in their 401K account.  I wouldn't consider that a "travesty" by a long shot!   Today, many employees move on and companies fold before the employees are eligible fore retirement leaving them with nothing in a pension play.  At least with 401Ks, the accumulated money can be moved with you.  All is not lost.

2
Comment #10 by Anonymous posted on
Anonymous
Read:
http://www.forbes.com/sites/kerryhannon/2013/01/13/the-three-surprises-in-401ks/

A visitor from out of town was touring Manhattan. Near the end of the tour they arrived in the financial district. When they arrived at Battery Park the guide showed him the expensive yachts, and said, "Here are the yachts of New York's bankers and stockbrokers." "And where are the yachts of the investors?", asked the tourist.

5
Comment #11 by decades posted on
decades
I  don't know where they find thier nerve ..I give them 11 grand a year and they don't even say thank you. At least my online broker gives me Christmas cards and preasants. In a few more years I'll be 59 1/2 and can move it where I want it . I won't move it all though , will leave about 2 cents

3
Comment #12 by Anonymous posted on
Anonymous
I have a long-time friend who earned an MBA many years ago. He has a 401K worth about 600K. He doesn't look at statements, know what his rate of return is or has been, pays a 1% ($6,000) annual fee to his adviser and THEN says candidly, "I don't get much face time with him since I'm just a small fish in his lake. The plan the last few years was to maintain the account and not lose anything." I found out what his balance was 6 years ago, performed some quick "buy the market" calculations and gave him the number...750K. He gave me the "I don't believe it look" so we finished breakfast talking about other matters. The point is even an MBA can behave like a mindless dolt.

Fees should be based on performance, but we know that will never happen.

2
Comment #13 by Anonymous posted on
Anonymous
decades ... We have about the same in CDs but earn 11-12K a yr. I hope  you are able to claim it as expenses in some way. but then I,d be ticked if you could :)

1