Wednesday, December 21, 2005

Cancelled my 401(k) Contribution

Earlier this month I cancelled my 401(k) contribution after re-prioritizing some of our financial goals. For several years, the mantra "max out the 401(k)" was helpful to me as my sole savings goal but my goals are getting more diversified as I learn more and it's time to do some adjusting.

When I made my goal early in 2005 to save $10,000 in an emergency fund by the end of the year, it was before my paycut. Even with my moderately successful efforts at reducing expenses, I only had $2300 saved at the end of November. My reduction in pay combined with the addition of a 50% health and dental contribution resulted in an $800 monthly reduction in my take home pay mid year (incidentally, you can see this reflected in my NetWorthIQ graph...it's interesting). This unforseen event really put a crimp in my savings rate.

My company does do both 401(k) matching and profit sharing 401(k) contributions...when there is a profit. Cash flow has been a problem all year for my company and it appears we will end the year with a net loss. In 2004, we received (theoretical) matching and profit sharing contributions, but they have yet to be applied to our 401(k) accounts due to the cash flow issues (and apparently it's costing the company even more money in penalty fees to stay in compliance because of that fact).

Essentially there will be no 401(k) matching this year so I will not forfeit any "free money" through a match. By cancelling before either of my December paychecks, I have still contributed nearly $13,000 to my 401(k) for 2005. When (if?) my 2004 bonus is applied to my account, I will treat it as a stand-in for the bulk of my 2006 401(k) contributions (psychologically that is...not in my calculated savings rate)

My twice-a-month 2005 401(k) contribution was $584. With that stopped, I do take a tax hit...of $177 per paycheck (Federal + State income taxes combined). So I am netting just over $400 more in my new paycheck. This means I now have $800 a month (starting with December) to put towards our emergency fund. LaLa's marginal tax rate is lower than mine, so she is also re-prioritizing the emergency fund over tax-deferred savings until we meet our goal.

Obviously cash flow issues and my ever declining salary makes me very concerned about the health of my company. It just finally sunk in that my most important goal right now should be the emergency fund.

I've already made my first $400 contribution to the emergency fund...bringing the Save-O-Meter up to 27% ...it's a start

3 comments:

  1. It is tough to stop or lower your 401(k) contributions. But having an fully funded emergency account is considered defense plan step #1 in my book. The only way to reconcile the need to maximize retirement savings with the need to maximize emergency fund savings is earmarking your ROTH IRA as your emergency fund since contributions to that can be withdrawn without penalty (since they are after-tax dollars - just the contributions, not the investment gains).

    Good luck with building that emergency account!

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  2. I totally understand your situation. I'd been working for a year not making contributions to our company 401k even though they did match 50% of the first 8%, but having some cash on hand just in case was much more important, especially considering I was only 21 when I got out of college and started working. If your company's not matching your contributions and you aren't itching to save on your current year taxes, then contributions to a 401k are just glorified savings that you can't easily touch for decades. Smart decision focusing your priorities on emergency savings.

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  3. Hi Caitlin,

    I'm not disagreeing with your choice. The experts suggest 6-8 months in savings to cushion any emergency. But "emergency" for most people usually means a job loss. You're gainfully employed so the emergency fund is for true emergencies, which I believe, would be minimal since you are good about living within your means. It’s not like you're going to having a monstrous credit card bill surprise you one month and this creates the emergency.

    If you did suffer a job loss (emergency) then you could withdraw the needed portion of the 401(k) funds at this time. However, if this happened, I believe you would figure out some other thrifty way to cover this "emergency" and automatically roll over these dollars to your IRA. I'm a believer in the structure that a 401(k) provides whether a company matches or not. Just offering up another view to ponder.

    Happy Holidays!

    Nina

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