In the current economic environment employers are evaluating all of their cost cutting options. In many cases this may lead to suspending or reducing their 401k match.
For employees of such companies this should prompt an evaluation of their current savings strategies. One of the golden rules you will hear in financial planning is that you should, at the very minimum, contribute enough to your 401k to receive the employer match because this is “free money.” However, when the matching program is suspended, this no longer holds true.
Some questions you should ask yourself when deciding if you should continue contributing to your 401k plan are:
- How would I use the additional money in every paycheck?
- What other savings strategies should I utilize?
- What would be the tax implications of discontinuing contributions?
This first question is key because part of the attraction of 401k deferrals is that they make retirement saving automatic, eliminating the opportunity to spend those funds rather than save them. This has become increasingly important in modern society with the reduced availability of traditional pension plans to cover our retirement needs. Without the automatic deferrals from your pay check, it will be important to establish other savings strategies to continue funding your retirement goals.
This leads us into questions 2 and 3, which are intricately related. The appropriate retirement savings strategies will rely heavily on your income level and tax bracket. You should evaluate what your adjusted gross income would be with and without your current 401k contribution. Before eliminating your deferral altogether you will want to make sure that this will not push you into a higher tax bracket, since traditional 401k contributions are made pre-tax. If you are in a low tax bracket then you may want to consider contributions to a Roth IRA instead of your 401k since withdrawals from that account will be tax free in retirement. As a result of lay offs and pay cuts over the past year, some individuals may now be within the income limitations to make Roth contributions when they were not in the past. This option should be analyzed as well.
For most employees a combination of some level of 401k and IRA (Traditional or Roth) contributions make sense. Seek the guidance of your financial advisor to help you evaluate your options when faced with a 401k match suspension.