If someone offered you free money, would you say no? Probably not. It may not seem like it now, but that's exactly what you're doing if you don't contribute to your 401(k). There are several benefits to a 401(k) plan, which we will review, and every financial planner will tell you to invest in one form of retirement account. So, instead, let’s cover an issue you are less likely to discuss—when you should stop contributing to your 401(k).
Before we get there, it's worth taking a look at why you’re participating in a 401(k) plan in the first place. Here we cover a few of the best perks, in order to help guide your contribution decisions.
Key Takeaways
- 401(k)s provide two separate tax breaks: You get a tax deduction for contributions, and your money grows untaxed until you take withdrawals.
- Many employers will match at least a portion of your 401(k) contributions, and that’s more or less “free” money.
- The tax-free growth and those extra employer contributions will stall when and if you stop contributing more money to your 401(k).
- Most experts recommend contributing to your 401(k) for at least as long as you’re working.
Tax Breaks
You get two tax breaks when you save in a 401(k) plan. First, the money you contribute is tax-deductible, meaning that what you contribute to a 401(k) this year will not be taxed as income this year. You will not pay taxes on the funds contributed until you withdraw the funds, typically in retirement. Your savings grow faster because they are tax-deferred. Your 401(k) enjoys compound growth untouched by the taxman until you retire and begin withdrawing the money.
Saving Made Easy
Investing in your 401(k) is “paying yourself first” because it ensures that you are supporting your future wealth. Steady saving is one tactic that millionaires employ. It’s also an easy way to save since your employer deducts your 401(k) contributions automatically from your paycheck so you won’t need to remind yourself to write a check. After a while, it’s likely you won’t even notice the money missing from your paycheck.
Without a 401(k), you’d have to set up a retirement account and consciously take out your contribution every month, which, let’s be honest, won’t happen the month you take a spontaneous vacation, have to make an unexpected repair or purchase a big-ticket item.
Note
A 401(k) typically allows for much more generous savings than many other types of retirement accounts, such as a traditional or Roth IRA, which have rigid limits on the amount you are allowed to contribute annually.
The 401(k)’s “forced savings” aspect also allows you to take advantage of dollar-cost averaging. Putting it simply, you consistently use the same amount of money to buy securities over time and this tends to lower the average cost of all of your shares. The market is consistently swinging, but putting money in on a regular basis via a 401(k) allows you to purchase shares when prices are low and will likely bounce back up later on. Since 401(k) investors are contributing to every paycheck, this is the default strategy.
Employer Matching
To encourage participation, in many cases, an employer will match a portion of your 401(k) contributions. Let’s say your company matches 70% of your 401(k) contributions up to 6% of your salary. If you make $100,000 and contribute $6,000 (6%) the company will pitch in $4,200. This is a deal you'd be wise not to pass up.
Good Saving Habits
Saving today via a 401(k) gets you into the habit of living frugally.For example, if you make $80,000 and contribute 20% to your 401(k), you’re actually living on $64,000. (Just be sure to watch out for the contribution limits.)
Note
A life-long practice of putting money aside for savings will pay off in your later years by allowing you to actually enjoy your post-career life on less income, which can help make your retirement money last longer.
So what happens when you stop contributing to your 401(k)? You guessed it—most of the above benefits go away.
- No more reduction in taxable income
- No more employer contribution
- No tax deferral on your additional retirement savings
- No more paying yourself first
Stopping your contribution dramatically slows the growth of your retirement money.It may feel good now to have that extra cash in your checking account, but when it's time to retire don’t you want to have saved as much as possible?
The Bottom Line
So when is the right time to stop contributing to your 401(k)? The most lucrative answer is the day you stop working. Take full advantage of the 401(k) plan your employer offers. A program that lets you save tax-deferred and, possibly, collect free money through an employer match can put you on the path to your dream retirement.
FAQs
If you're close to retirement and have already amassed a substantial nest egg, or are about to start taking distributions, you may not need to continue to contribute to your 401(k). After all, with such a short timeline, your rate of return is likely to be on the lower end.
At what point should you stop contributing to 401k? ›
A general rule of thumb says it's safe to stop saving and start spending once you are debt-free, and your retirement income from Social Security, pension, retirement accounts, etc. can cover your expenses and inflation. Of course, this approach only works if you don't go overboard with your spending.
What is the time limit for 401k contributions? ›
31. The answer is that because 401(k) contributions are made through payroll deductions, Dec. 31 is the deadline. However, if you have an IRA, you can contribute to that account up until the 2023 tax year filing deadline, which is April 15, 2024.
Should I keep contributing to 401k right now? ›
401(k) contribution options
While you shouldn't stop investing in your 401(k) during a market downturn, there are some things you can do to help protect your saved cash. Set retirement goals: Without a plan, going into any extensive life choice isn't a promising idea. The same goes for investing.
Should I stop my 401k contributions to pay off debt? ›
If you have low-interest rate loans and expect higher returns on the investments in your 401(k), it may be a good strategy to contribute to your 401(k) while chipping away at your debt—making sure to prioritize paying off high-interest rate debt.
Should I stop contributing to my 401k during inflation? ›
Some decreases though, like cutting back on 401(k) contributions, can be more harmful than helpful. While it may be nice to have a few extra dollars today, every decrease pushes your retirement date back and pauses the opportunity for your money to grow for the future.
Can you stop your 401k at anytime? ›
Typically, you can't close an employer-sponsored 401k while you're still working there. You could elect to suspend payroll deductions but would lose the pre-tax benefits and any employer matches. In some cases, if your employer allows, you can make an in-service withdrawal if you've reached the age of 59 ½.
Is 40 too late for 401k? ›
If you're starting to save for retirement at 40, that's not ideal, but it's also far from being too late.
Can I contribute 100% of my salary to my 401k? ›
Can I contribute 100% of my paycheck into my 401(k)? While you may be looking to contribute your entire paycheck to your 401(k), required federal and state withholding typically prevents you from doing so.
Does 401k have 5 year rule? ›
Contributions and earnings in a Roth 401(k) can be withdrawn without paying taxes and penalties if you are at least 59½ and had your account for at least five years. Withdrawals can be made without penalty if you become disabled or by a beneficiary after your death.
The worst thing you can do to your 401(k) is to cash out if the market crashes. Market downturns are generally short and minimal compared to the rebounds that follow. As long as you hold on to your investments during a bear market, you haven't lost anything.
What will happen to my 401k if the dollar collapses? ›
If the dollar collapses, your 401(k) would lose a significant amount of value, possibly even becoming worthless. Inflation would result if the dollar collapsed, decreasing the real value of the dollar when compared to other global currencies, which in effect would reduce the value of your 401(k).
Where is the safest place to put 401k after retirement? ›
The safest place to put your retirement funds is in low-risk investments and savings options with guaranteed growth. Low-risk investments and savings options include fixed annuities, savings accounts, CDs, treasury securities, and money market accounts.
Do millionaires pay off debt or invest? ›
Millionaires usually avoid the following: High-interest debt: Millionaires typically steer clear of high-interest consumer debt, like credit card debt, that offers no return or tax benefits. Neglect diversification: They don't put all their eggs in one basket but diversify investments to mitigate risks.
Is it smart to pull from 401K to pay off debt? ›
It can put you at risk later on in life when you are older, not working and would otherwise need to rely on those funds. There are also short-term effects from making an early withdrawal from your 401(k) as well: It doesn't come free. Doing so has costly consequences, including both a penalty fee and taxes.
Is it better to pay off mortgage or contribute to 401K? ›
Is it better to put money in a 401K or pay off the mortgage? The earlier you can start saving in a 401(k), the better. A 401(k) is tax-advantaged and if you work somewhere with employer matching, that's a way to earn free money. Putting money toward your mortgage can help reduce the amount you pay in interest.
Why you shouldn't max out your 401k early? ›
It's never too early to set up a 401(k)—but there's no real benefit in maximizing your contribution as quickly as possible when offered an employer match. By maximizing your 401(k) annual contribution at the beginning of the year, you could miss out on your employer's maximum matching contribution.
Is it better to max out 401k or Roth IRA? ›
If you don't have enough money to max out contributions to both accounts, experts recommend maxing out the Roth 401(k) first to receive the benefit of a full employer match.
