Don’t Max out Your 401k

If you were to get on the Internet and poll the financial gurus, the message you would get load and clear is: Save Money. No matter how much you’ve saved, you will be woefully short when you get to retirement.

The first suggestion of these pundits? Put money in your 401(k). (I will use “401(k) as a surrogate for all retirement savings plans: 401(k), 403(b), SEP, SIMPLE etc.) I’m not against 401(k)s. Actually, I’m a big fan. However, I think the advice is wrong.

Here’s my message: Save 10% of your income. Put your money in a savings account. This will become your emergency fund.  Accumulate 10% of your annual income in your emergency fund if you’ve got a regular job. 20% if you worry you’re on the brink of losing your job or are self-employed.

For the first 6 months or so, this amount might seem measly and the whole project might seem like it’s not worth it. You can supplement your saving by putting in money from any cash gifts, tax refunds, or other windfalls. Don’t put 100% of the unexpected money in your saving. Put 33% to your savings, 33%toward your credit cards or other debt, and 33% go out and spend. If you don’t have any debt, the proportion is 50/50.

Once you’re got a fully funded emergency fund, start saving in your 401(k). But even then, don’t max out your 401(k). Find out what your company match is. (Your company match is how much your company puts into your 401(k) for every dollar you do.) Instead of putting the 10% of your saving into your emergency fund, contribute to your 401(k) up to the company match. If your company doesn’t have a match, start putting 3% into your 401(k). With the other 7% of the earnings you are setting aside, start saving for a house.

Don’t max out your 401(k) until:

You have an emergency fund You have paid off your credit cards You have bought a house or condo (or know that you either have enough saved for a down payment, or that you will never buy a house.)

That means that if you are maxing out your 401(k) now and don’t have an emergency fund, stop maxing out your 401(k).  Does this sound like heresy? I’ll say it again. STOP.

I recommend this because the number one thing you can do lower your financial angst is to have an adequate emergency fund.  Grow up and stop living paycheck to paycheck. Adding to your 401(k) won’t lessen your current angst, establishing an emergency fund will.

What if you try this and, after a year, you haven’t accumulated any savings? In other words, what if you’re incapable of leaving the money alone? Cut up your credit cards. Start paying for everything with cash. A colleague of mine, Ken Robinson, has a terrific book that just came out about how to start saving. It’s called Don’t Make a Budget.

If you can’t figure out how to save, or if you try and you just can’t do it, get his book.

Sometimes people object to this advice. But Bridget, they say, money in a savings account isn’t doing anything. It’s just sitting there.

I tell them, instead of thinking your money is just sitting there, think it’s meditating. Your money is meditating so you can relax.

Besides, these days, with the Internet, there are high-interest savings accounts. I like INGDirect, and a lot of advisors I know recommend Emigrant Direct.

These are online savings accounts that make it easy to transfer money from your checking account, are insured up to $250,000 per account by the FDIC, and offer a higher interest rate as part of their marketing strategy. The two banks I mentioned have offered high rates for more than 5 years, so I don’t believe their interest rates are one-time teasers.

What’s the difference? ING Direct is paying 1.3 percent now.  I saw a recent Fidelity statement showing a money account earning .07 percent. Chase currently pays .01 percent for the standard savings account. That means that if you have $10,000 in your savings account, you’d make $130 a year at ING Direct, $7 at Fidelity, and $1 at Chase. At Chase, you could argue your money wouldn’t be doing much.

But one thing you know for sure is that it won’t be going down. There’s some charm in that. People who have lost money in the stock market plunge can see a lot of charm in that.

About the author

Bridget Sullivan Mermel, CFP®, CPA

Hi. My name is Bridget Sullivan Mermel. I started a fee-only financial planning firm, Sullivan Mermel, Inc. We especially enjoy working with attorneys, small business owners, near retirees, and clients interested in socially responsible investing.

We practice in a small niche of the industry called fee-only, which focuses on giving un-biased advice. We don't take commission, get kick-backs, or sell products. We have no hidden agendas. Our focus is on giving our clients the best comprehensive advice possible.

I started out with a tax practice in 1997. I could see that clients wanted and needed help not just with their taxes, but with other areas of their personal finances, too. When I found out about fee-only advising, with its emphasis on giving bias-free advice, I was hooked! I love helping people understand and improve their fiances.

I worked as manager and district manager during the start-up phase of Starbucks. I also worked supporting high profile litigation and in the back office of a derivatives firm.

I have a BA in Accounting and Marketing from the University of Wisconsin, Madison and a Masters in Liberal Arts from DePaul University in Chicago. I am a Certified Financial Planner™ as well as a Certified Public Accountant.

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