A reader recently asked whether or not they should stop contributing to their 401(k) plan to get out of debt faster. This is a question anyone eager to become debt free has asked themselves, and there is really no right or wrong answer. I do have a couple guiding principles that may help you decide, but in the end it is a personal finance decision between you and your family. Similar to other unconventional financial advice, the best plan is not always the smartest one, mathematically. Mathematically, it makes sense to continue retirement contributions to take full advantage of compounding interest. However, laser intensity can sometimes make up for math and by focusing all your resources on becoming debt free can immeasurably improve your life.
photo by: Thiru Murugan
Dave Ramsey is Right: Intensity Changes Everything
I don’t agree with everything Dave Ramsey says, but he is right on this one. Ramsey advocates suspending retirement contributions while working to become debt free. However, he also offers a couple stipulations that I also agree with. First, do not suspend retirement contributions if it will take longer than eighteen months to become debt free. Giving up eighteen months to two years worth of compounding growth may prove too costly for those hoping for an early retirement. So if you have thousands of dollars in debt, and don’t have enough cash flow, even after suspending retirement contributions, to clear this debt in less than a year and a half then do not suspend your retirement contributions. Consider continuing contributions to your 401(k) and as quickly as possible continue paying off your debts.
If you do suspend retirement contributions make getting out of debt your number one priority. The longer you do not contribute to your 401(k), the more you are sacrificing in potential growth. In a down market like the one we are currently in, it is tempting to want to buy mutual funds at a deep discount. However, contributing a couple hundred dollars towards retirement each month can significantly slow your debt elimination progress, possibly costing you much more than you could earn in growth.
Reminder, it is a Personal Decision
Many people will provide a host of reasons why this idea is flawed, and I suspect a few will do so in the comments here. That’s fine. Like I mentioned in the opening paragraph, the decision to suspend retirement contributions to attack debt is a personal one. You could run some elaborate formulas to determine the money paid in interest on debt versus the money earned by contributing to a retirement plan and come up with many different conclusions based on different factors. Two points for paying off debt:
- Eliminating a 14% credit card is a sure 14% net gain, but investing in a stock or mutual fund averaging 14% is not a sure thing. As the prospectus states, “past performance is not a predictor of future gains.”
- Removing debt from your life reduces risk, something most mathematical formulas fail to include in their calculations. Living debt free gives you options, and frees up earnings for future investments.
Ask the Readers: Have any of your temporarily suspended retirement contributions to become debt free?