With rents, food prices and child-care costs all rising, coming up with the cash to cover unexpected expenses is becoming more difficult. Even among wealthy Americans, the stock market downturn means plenty of them also find it tough to come up with the cash to pay for things like surprise home repairs or dental work.
When interest rates were low, borrowing money to make up for a temporary shortfall was relatively easy and didn’t come at such a price. That’s changed. Credit-card rates are approaching 20%, personal loan rates are north of 10% and home equity lines of credit can be hard to come by.
For some people, reducing retirement contributions temporarily or even borrowing from a 401(k) may be smarter than piling up high-interest debt. Yes, traditional personal wealth advice directs savers to “set it and forget it” when it comes to 401(k) retirement plans. But while I’m by no means encouraging people to be reckless with their 401(k)s, I do think some of the stigma and taboo around adjusting retirement savings when in financial straits needs to change.
Assuming cash-poor families have already done a budget review and cut unnecessary expenses, dialing back on retirement savings could be the least-painful short-term fix. Remember, there aren’t annual reminders or enrollment periods for existing employees when it comes to 401(k) plans like there are when making elections for health benefits. Most people set a contribution rate when they start a job and leave it there for years. Sometimes external circumstances warrant making a change for a period of time.
The “least harmful” change to make is to reduce your 401(k) contribution amount. There are tentative signs some workers are already doing this. A recent report by T. Rowe Price Group Inc. shows how there was a slight decline in the average contribution rate among its plan participants starting at the end of May, which coincides with when inflation was starting to peak.
To me, that makes sense sometimes: Tweaking the percentage of your salary that’s going to retirement may provide enough of a bump to deal with any short-term financial strain. The size of the increase you’ll get is influenced by your salary and withholding amount, among other factors. (But keep in mind, you may have a bigger tax liability, too.) Bankrate.com has a helpful calculator.
For those who are going down this path, it’s crucial to limit how many months you’ll be contributing less to avoid getting used to the pay bump. Pick a date to stop and remind yourself to increase your contributions again after that time.
In addition, plan to use future raises or bonuses to get back on track, says Mark Wilson, a certified financial planner in Irvine, California.
Also, if you’re leaving any portion of an employer match on the table, you may want to reconsider making contribution changes — in that case, taking on debt, even if it’s expensive, may be better than passing up free money.
Another word of caution — make sure you’re reducing or cutting contributions because you really need to, not because you’re panicking about the stock market decline. While it feels counterintuitive, continuing to put money into your 401(k) while stocks are down will actually help you come out ahead.
If a change in 401(k) contribution levels isn’t enough, most plans will also give you the option to borrow from your retirement account. The rules vary based on an employer’s plan, but most loans have to be repaid within five years. The interest rate is lower than a credit card — currently around 7% — and unlike with a bank, the interest you pay goes back into your retirement account. You can take up to 50% of your vested retirement account balance or $50,000, whichever is lower.
The most important caveat with a 401(k) loan though is that if you leave your job, you’ll typically have to repay it no later than when your taxes for that year are due. If you’re unable to do so, the unpaid balance will be treated as a distribution and you’ll be on the hook for income taxes as well as face a 10% early withdrawal penalty if you’re younger than 59 and 1/2.
Notably, only 10% of 401(k) borrowers default on their loans, but 86% of those who leave their jobs with an outstanding loan wind up defaulting, according to a paper from the National Bureau of Economic Research.
The paper also points out how people may save more in their workplace-based savings plans if they feel like they’re more flexible and liquid.
It’s another reason why including a 401(k) in the discussion about what to do if you’re strapped isn’t always the worst thing in the world. Still, any tweaks to a retirement savings plan should really be thought of as a stopgap fix. Permanently reducing or suspending contributions will have dire consequences for retirement, especially if you're young and have years for returns to compound.
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