Should I Stop 401(k) Contributions to Pay Off Debt?

A reader recently asked whether or not they should stop contributing to their 401(k) plan to get out of debt faster. This is a question anyone eager to become debt free has asked themselves, and there is really no right or wrong answer. I do have a couple guiding principles that may help you decide, but in the end it is a personal finance decision between you and your family. Similar to other unconventional financial advice, the best plan is not always the smartest one, mathematically. Mathematically, it makes sense to continue retirement contributions to take full advantage of compounding interest. However, laser intensity can sometimes make up for math and by focusing all your resources on becoming debt free can immeasurably improve your life.

intense sunlight
photo by: Thiru Murugan

Dave Ramsey is Right: Intensity Changes Everything

I don’t agree with everything Dave Ramsey says, but he is right on this one. Ramsey advocates suspending retirement contributions while working to become debt free. However, he also offers a couple stipulations that I also agree with. First, do not suspend retirement contributions if it will take longer than eighteen months to become debt free. Giving up eighteen months to two years worth of compounding growth may prove too costly for those hoping for an early retirement. So if you have thousands of dollars in debt, and don’t have enough cash flow, even after suspending retirement contributions, to clear this debt in less than a year and a half then do not suspend your retirement contributions. Consider continuing contributions to your 401(k) and as quickly as possible continue paying off your debts.

If you do suspend retirement contributions make getting out of debt your number one priority. The longer you do not contribute to your 401(k), the more you are sacrificing in potential growth. In a down market like the one we are currently in, it is tempting to want to buy mutual funds at a deep discount. However, contributing a couple hundred dollars towards retirement each month can significantly slow your debt elimination progress, possibly costing you much more than you could earn in growth.

Reminder, it is a Personal Decision

Many people will provide a host of reasons why this idea is flawed, and I suspect a few will do so in the comments here. That’s fine. Like I mentioned in the opening paragraph, the decision to suspend retirement contributions to attack debt is a personal one. You could run some elaborate formulas to determine the money paid in interest on debt versus the money earned by contributing to a retirement plan and come up with many different conclusions based on different factors. Two points for paying off debt:

  • Eliminating a 14% credit card is a sure 14% net gain, but investing in a stock or mutual fund averaging 14% is not a sure thing. As the prospectus states, “past performance is not a predictor of future gains.”
  • Removing debt from your life reduces risk, something most mathematical formulas fail to include in their calculations. Living debt free gives you options, and frees up earnings for future investments.

Ask the Readers: Have any of your temporarily suspended retirement contributions to become debt free?

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Comments

  1. Oh, how I’ve wrestled with this question. Ultimately, my husband and I decided to continue maxing out my 401k and focus on paying off my credit cards within one year. If we haven’t finished by the end of the year, we’ll reassess. It was a tough call, though…

  2. I find that another huge factor is how old you are. I’m going to be honest here, my husband and I are 26 and 25 respectively. If we take a year or two off retirement savings to pay down his student loan, we’ll still probably have a good 25-30 years to build up the 401k.

    But no, we haven’t stopped putting money in the retirement account. My husband’s mother has saved zippo for her retirement (not really her fault, for reasons I won’t get into) and we see her struggling vs my parents (who make more in retirement than we do now) and figure that we can always work extra hours now to pay down debt now and that’s something we know we’re not going to want to do when we’re 65.

  3. I think it depends on two issues: (1) will you really ramp up your investments after you get out of debt, and (2) how much time/money are you going to lose.

    Personally, we suspended our 401k contributions for a year and a half while we built our house. We did lose ~3 grand in company matching money, but we more than made up for it with an improved quality of life during a very stressful situation.

  4. I certainly don’t think it’s flawed. The argument that you can’t give up retirement contributions because of compounding is flawed because debt compounds the exact same way – and in same cases, much faster.

    Thanks to all the investment companies marketing (propaganda) everyone thinks you need to have a ton of money to retire and you have to start really early. This unfortunately doesn’t jive with the reality of having a family, house etc. Most people can start saving (hard) at age 40 after paying off all their debts and still have a good retirement at age 65. I’m not suggesting that’s the best way to do it, but you don’t have to start saving at age 21.

    Mike

  5. I recently struggled with this issue myself, and even wrote a post about it. What made me decide to continue with my contributions was the company match, which is 50% up to 5%. If I did not get the match, I think I would stop contributions. What is your opinion if there is a company match involved?

  6. @Think: If there is a company match involved it does make me lean towards continuing contributions up to the match, but no further. However, even with matching contributions from an employer it does not change the argument that intense focus on getting out debt makes it happen even faster. If you did decide to contribute through the match you would be diluting that intensity ever-so-slightly.

  7. Whether your readers ulitmately decide to stop their retirement contributions or not, I do hope all of them make the decision to get OUT OF DEBT!! (Thanks for the link :) ) It isn’t just about the freedom or options that become available, it’s about being able to survive whatever curveballs life may throw at you … it’s a whole lot easier when you don’t have payments going out six ways from Sunday!

  8. I have to say you go for the free money from the company match. If you get a 50% match up to 5% of your pay then you are instantly getting a 50% return if you contribute 5%! That’s better than the 14% instant return from paying off debt. And on top of that you get a tax break on the 5% you contribute.

    I’m not saying you don’t intensely focus on paying off your debt. That is important and needs to be done. And as you said it is a personal issue in the end and each person needs to evaluate their finances.

  9. I think a lot also depends on how much your employer is matching. If it’s in excess of your highest interest rate on your debt, there’s a lot to be said for taking advantage of that. I’ve worked for companies with up to 100% match!

  10. I agree with a lot of the comments…contribute only that percentage where there’s a company match. It may only be 5 percent. You’ll barely notice it (especially because it’s pre-tax).

    I’d go so far to say, however, ALWAYS contribute just enough to get the company match. Then max out any IRA contributions you can make, followed then by putting as much in your 401k as possible.

    Reason? 401k plans are notoriously lacking in GOOD investment choices. Getting the company match gets you double your money (assuming a 1 for 1), even if your investment choice(s) do NOTHING for the year.

    You have much more flexibility with an IRA (Traditional or Roth).

    Ask your benefits provider if there is an alternative to the meager funds your 401k plan offers. I asked and found that I could use Fidelity’s BrokerageLink and buy whatever I want in my 401k. This is NOT publicized by the benefits folks or Fidelity. There was a small bit of paperwork, but now I can invest in virtually anything.

    It’s worth asking about.

  11. I actually stopped my contributions for a couple months to focus on a couple small debts. I get matched up to 6% normally, but after I paid off the smaller debts, I set my contribution to just 3%. It gives me a bit more cash monthly to focus on my remaining ($55k school loans, $20k for car and $10k other) debt, but still give me a bit of compounding interest and a bit of the “free money!” match.

    I’d really like to just stop it again and smash the rest of my debt faster, though!

  12. My husband and I are also in the same boat.

    My husband is 37 years old and just started to contribute to his 401K at work. He was working P/T while going to school F/T and he was primarily working for health insurance and for a daycare benefit. With 2 kids in daycare F/T and with our health insurance premiums, his checks were very very small (like $20 small). When he finally graduated and started working more hours (now F/T), we decided to be aggressive and started to contribute 25% to his 401K (this decision was made prior to us working on our financial house). His employer matches 100% up to a 4% contribution. Well, after making the 401K contribution and still paying for daycare and health insurance, his take home pay didn’t improve much. So, we dropped his contribution down to 10%. I would really like to drop it down to 4% (don’t want to lose out on free money :) )until our debt is paid off but he would like to continue the 10% contribution since he has very little retirement savings and because of his age.

    We are currently working on a debt snowball and doing very well with it. We should be debt free (except the mortgage) within 12 months.

    I think we will compromise and meet half way and adjust his contribution to 6 or 7%. We’ll discuss it at our monthly budget meeting tomorrow :)

  13. I decreased my 403b contributions to 1% until my debt is paid off and my emergency fund is healthy. This was a tough decision, but I think I’ll only need 8-10 months to meet these two goals, and then I can increase my contributions again. Another thing that I considered was: I have a separate pension to which the state contributes for me, and there is no match on my 403b. I think I’m getting more bang for my buck at this point by paying off the credit debt and increasing the EF in the short term.

  14. Just another vote for contributing as much as will be matched (at least). If your state and local taxes are at a marginal rate of 25% then a dollar contributed only costs you 75 cents, and if there is a 100% match you end up with $2.00 in your retirement account. You are already at 166% return on what is really missing from your take home pay ($2 vs .75), that is something to give up only as a last resort! Even with no match you start out at a 33% return because of the tax avoidance – $1 in retirement from missing out on 75 cents from your check.

  15. I concur for keeping the contributions if you are getting any kind of matching.

    My wife and I are in the same boat. In our circumstance, my employer contribtes 35%, so even if the market is stagnant at 1%, I still made 35% and it will compound over time. Currently my account is still doing about 5-6% even in this economy. Paying off debts to me is just as important, but with determination, there is no reason to stop the 401k train just to pay off debt a few (dozen) months sooner. We are concentrating on selling things we don’t need, cutting back expenses and shooting for more overtime.

    Nice Blog, Frugal dads ROCK!

  16. I agree that it is hard for people to wrap their minds around giving up the free money from a match. I agree with Frugal Dad that if your income is being used to eliminate debt with focused intensity then you will be able to catch up when you are done paying off your masters!

    Mathematically it doesn’t make sense, but like Dave Ramsey says, if we were doing math the whole time then we wouldn’t be in debt in the first place!

  17. I continued to contribute to my retirement fund but reduced my contribution until I had paid off my debt and established my emergency fund. Then I raised my retirement contributions to the recommended 15%.

    Unless your debt is huge, I don’t see why it has to be all or nothing, especially if you get a company match.

  18. Yes, I temporarily suspended ira contributions while paying off debt. I have IRS debt from 2004 (what rebate check!) and I have to pay it off asap. and I’m looking for work. so I’m doin the best I can

  19. It has been said of course, but this is how I personally think it should go if you are really loaded:

    *Contribute ,up to the max of matching only, to your 401k
    *With the remainder, get debt free.
    *Once you are debt free, get a house.
    *Once you have a house, max out Roth IRA contributions if you are young enough for that to be a good idea (<50 or so?)
    *Max out regular IRA (more flexible than a 401k) if you are still eligible.
    *Max out 401k.
    *Invest in other non-tax deferred vehicles of your choice.

  20. I agree that this is a personal decision…and one that my wife and I think is a good idea. I’d rather pay a little less into 401K than increase credit card debt. I never even thought of doing this until I read this article so thanks for the idea! Love your blog.

    –TW

  21. Excellent article, and I have enjoyed the comments. Andy C is the only one that brings up the fact that all those 401K dollars are pre-tax contributions. If we stop putting money into the 401K, we go up to the next tax bracket and see very little of the money on the paycheck. That money ends up going to the IRS instead of our retirement fund. NOT that anything is growing much right now, but I’d rather pay myself than Uncle Sam, given the choice.

    This decision, whether or not to suspend matching 401K contributions has caused us much grief as we have tried to figure out the best way to relieve our debt load with intensity. In the end, we ended up leaving the contribution as it was. I still don’t know if it was the right choice, but there you go!
    TM

  22. All of the blogs I’ve read are helpful, and relatable. My question is; “Will my company match the contributions I’ve made for the past 10 months of this year, now that I have suspended my contributions to pay down debt”, or do I lose the match altogether”? I made the decision due to the money I had loss, as a result of the downturn in the market.

  23. I’m in a unique situation where I have about $17k of debt. I’m 42 y/o, and all of my debt is at 0% for the time being. I believe I can pay it off before the APR resets in ~12 months. I have a 401K with a 50% match up to 8% that I currently contribute to in order to get the match. I’m considering suspending my 401k contributions for 6-8 months to payoff the ~$17k in debt, then maximizing my 401k contributions once I’m out of debt and aggresively saving for an emergency fund. What do you think?

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