Normally it’s brilliant to take advantage of and make contributions to your 401k. When you do, you get an immediate tax break (unless it’s a Roth 401k) and you build up a nice retirement nest egg for yourself to boot. Not bad. But there are 3 situations where making contributions to a 401k is a bad idea. Let’s take a closer look.
When Not To Contribute to a 401k
There are at least five situations when you should not invest in a 401k retirement plan.
First, if you have high cost debt (like credit card debt), you should pay that debt off first (as long as you’ve taken steps to cut your spending and eliminate this problem once and for all). The reason for this is because credit card debt usually costs you much more than you can earn on your 401k. Even if you get a match from your employer, that match is typically limited to a small amount of your total contributions for the year.
If you have credit card debt and your employer matches the first $2000 you contribute to the 401k plan. You might decide to first contribute $2000 and then cut off your 401k payments and direct all your resources to getting rid of that rotten debt.
If you need life insurance and can’t afford it, you should buy the right insurance and the right amount before contributing to your 401k. That’s because you really never know when your number is up. If other people rely on you financially, they come first.
Neal’s Note – If you do contribute to your plan, are you investing wisely?
3. Higher tax bracket.
If you are sure you are going to be in a much higher tax bracket when you retire than while you are making contributions, you should not build a 401k. That’s because you’ll get the tax break for making the contributions when your tax bracket is low. But you’ll incur taxes when you take the money out during retirement – when your taxes are much higher.
On the face of it, this is true but be careful. It’s hard to know what your tax bracket is going to be in the future. Unless you are certain of this, don’t use the tax bracket issue as an excuse to justify not contributing to the 401k.
4. Shaky Employer
If you fear that there is employer fraud or that the company is on its way out, you should not invest further in your 401k plan. Even though companies go bankrupt all the time and 401k plan contributions are generally safeguarded, I suggest you pause.
In most cases, your money is safe regardless of what happens to the firm you work for. But sometimes the firm itself acts as custodian. If that is the case, the last thing you’d want to do is put more of your money into the hands of a firm in financial trouble.
5. Investment Options
The last thing to think about is the availability of investment options. If your employer only allows you to invest in company stock with 401k plan money, I would not contribute a dime. And if your employer has an extremely limited menu of options, I’d probably limit my contributions to the matching level and stop there.
In fairness, there really is one more reason why you shouldn’t make use of your 401k and that is if you have higher paying alternatives outside the plan. But be mindful of the risk and security. The only investment you can’t make inside a 401k that you can make outside the plan is real estate.
But it’s tough to buy real estate with the monthly contributions you would make to a 401k plan. You need a larger lump sum for a down payment to get the ball rolling. For most of us, real estate is not a real competitor for 401k contributions.
Bottom line? Read this list. See which conditions most closely describe you. Then decide if you should contribute to a 401k or not.
Are you participating in a 401k plan at work? Why or why not? What are your frustrations and fears? What benefits do you enjoy that I haven’t described above?