Struggling Americans Raiding 401(k)s

Yikes! Details:

A study finds middle-class families are turning to retirement money to get through financial crises such as unemployment and medical emergencies.

Bad idea.

Comments

[Angie]

Should I be fully funding my 401k at this point in time before paying down student loan debt at about 8%?

[Rick]

No

[Kim]

I think that "bad idea" is easy to say when you have other options. So, let's see...I am unemployed; can't find a job with so many people in my community being laid-off; my house is going into foreclosure which will threaten the safety of my family; lost my health insurance and one of my children is in desperate need of surgery. Oh right, funding my retirement in 25+ years is much more important, so I should sit tight and try to find some kind soul who will loan me (unemployed and in serious financial condition) money that I will also not be able to re-pay on a timely basis anyway. Stop and look around for a minute! There are many good, responsible people out there who have not over-spent themselves, but still find themselves now very desperate with no where else to turn. They did a very responsible thing when they could by putting 401K money aside. So now, if that is their sole source of paying the bills that they must pay for the safety and welfare of their family -- how can you criticize them for that? I just don't get it!

[Matt H]

Angie, it depends. By "fully funding" do you mean putting in as much as the law allows, or capturing your employer's match? Also, are you able to make your payments on the loan if you're also funding the 401(k)?

[rwh]

Angie:

Do both. Make regular contributions to your 401k and IRA and regular payments to your student loan. Since your student loan is at 8% you should probably put more emphasis on eliminating the debt, but it's important to start the retirement account when you are young (I'm making an assumption about your age) in order to take advantage of time to grow your investment.

In the interim, don't accumulate any other debt, particularly unsecured credit card debt. If you absolutely have to have a car and have to borrow, buy a used economoy car that has a reliable reputation (like a Toyota Corolla, Honda Civic or Ford Focus) for basic transportation and resist paying more for something cool.

Angie - Here are what I recommend as your financial priorities, not knowing your age or income.

1) Set aside $1000 in an emergency fund
2) Put as much as you have to into the 401k to get the full employers match (Usually ~6% of your salary).
3) Pay off any credit cards regardlss of interest rate, smallest balance first.
4) Fully fund a Roth IRA ($5000/yr) unless if you do this, you can't afford your bills.
5) Then pay extra on your other debts (student loans), highest interet rate first.
6) Build up your emergency fund to $10,000-15,000.
6) Then fully fund your retirement or other savings.

People may disagree with this approach, but it's important to start saving for retirement NOW. Student loans at 8% are tolerable to keep around for awhile.

[FMF]

Kim --

I think the "good, responsible people out there who have not over-spent themselves, but still find themselves now very desperate with no where else to turn" are in the vast minority. I think most of the people borrowing against their 401ks are trying to keep up with a lifestyle they really can't afford -- keeping a third, expensive car, funding a 500-channel cable TV bill that they "have" to have, sending their kids to this summer camp and that summer camp. For these people, borrowing against a retirement plan is a very bad idea.

What do I base these conclusions on? 20 years of dealing with people and their finances. In addition, we all know that even when the good times were going, most people were saving little if any to fund their lifestyles. Now that times are bad, they're tapping any source they can to keep up the lifestyle.

Sorry to hear about your situation. Sometimes a "perfect storm" hits people's finances and things that are not good ideas are the only options left. I hope you'll see your way through this and eventually be able to recover.

["Mo" Money]

Time is an important factor in the compounding of interest, if you wait you will lose the factor that can never be overcome. Even if you invest more later, you will never have the same amount as if you had started earlier.

[Angie]

I am currently just paying the 6% to get the 7% match. But that leaves me underfunding the yearly maximum by about 9,000 (since employer match doesn't count towards pretax as I understand). I can either increase to the maximum and have about $400 extra towards my loans each month, or keep it as is and apply about $1,000 extra per month.

All together it will add about 2 years, at combined payments around 2100/mo., (finish 2016 vs 2014) to the end of payments on my student loans. Is it worth having my 401k fully funded while I'm paying it off? So I will have more in there pre-tax

I'm 23 and 2008 is my second year contributing. Also, take into account the current market making everything a short-term "losing" investment.

[LC]

Angie - It's up to you which you want to do. If paying off the loan sooner is a bigger priority for you, then do that. I think it's obvious that you're on the right track and financially it won't make a big difference. But after the full match, I would make sure you have a substantial emergency fund and fund a Roth IRA with any extra retirement money (up tp $500, then go back to the 401k). The benefit of a Roth is you won't ever have to pay taxes on it when you take it out. Plus you can withdrawl it at any time without penalty (only your contributions).

FMF - I agree with your comment but your original post refered to unemployment and medical emergencies. These are things that happen to responsible people too and even a substantial emergency fund is not always enough. And some would argue that a loan from a 401k is better than putting expenses on a credit card.

[LC]

I meant to write $5000 as the Roth limit.

[rwh]

Angie:

It sounds like you have a pretty good income and a pretty sizable student loan debt. Not knowing how your 401k is invested you might want to diversify by starting an IRA instead of increasing your 401k beyond the employer match. I don't think you have to "max out" your retirement contributions if it means paying for two more years on your student loan debt.

It sounds to me like you are off to a very good start on both so paying off the debt sooner rather than later, while continuing to fund your 401k and IRA (although not fully) should be a good strategy.