When can you start using a 401(k)? On a smaller salary, isn’t it better to save liquid cash or in another vehicle? When is it possible to save TOO much for retirement?
Tip: If you are matched, you should *always* contribute up to the match. Why? Because if you’re strapped for cash, you can take that money (and the match) out now with a 10% penalty. You’re still better off. A lot of places giving you the advice to contribute to the match as your first step don’t mention this option, but it is an important one if you are low income. They don’t mention it because they don’t want people to get into the habit of draining retirement savings. But it’s still free money with the penalty, just less free money.
If you have a truly small salary, chances are you also don’t *have* 401(k) options. But if you do, at what point should you not save at all? If you’re in a situation where social security will be replacing most of your income. In that situation your spending is already really low and you are probably talking serious (health, safety, etc.) risks for cutting it more because you are already living in poverty.
Sidenote: If you do have extra each month because your salary is small but not at poverty levels, the Roth IRA is a good place for a longer-term emergency fund because you can take out the principal without penalty. There are also some pretty nice tax credits for low income people who put money away for retirement, which could mean up to a 50% return on up to $2-4K of your savings at tax time depending on your situation. (Note it might be worth getting the match for the credit, but not completely maxing out the IRA/401K depending on your situation.)
Is it possible to save too much for retirement? Of course. That happens when you’re hurting your consumption today in unhealthy ways in order to save huge amounts for you don’t know what tomorrow. For example, back when DH and I both had university jobs, we were saving 12% of our incomes mandatory, then we had room to save an additional 17.5K each in 403(b) and an additional 17.5K each in 457(b) and whatever the max was each for IRAs (maybe 4K?). We didn’t use that room. We have no plans for early retirement and were living with one car in a house without important furniture like a washer/dryer and there was a baby on the way. We needed the income more than we needed to max out our retirement spending.
Now we wish we had more space to save for retirement (coincident with us having less room to save since DH no longer has access to a 457 and his 401k sucks). That’s because we’re making more money now and it doesn’t really hurt us today to put more money away for tomorrow. Looking ahead, whether or not our kids are eligible for financial aid will depend a lot on how much we have in non-retirement savings. The more we hide in retirement savings and our house the less we’ll have to give to a private university with a huge endowment.
So what do I recommend one’s savings strategy be (as always, I’m not an expert– consult with a real expert before making important monetary decisions)?
- Contribute your 401k up to the match. Take the money out at a 10% penalty if (2) or (3) are problems.
- Pay off your high interest debt and do not create any more of it.
- Get a small emergency fund that will help you not accrue the kinds of fees you get hit with when you don’t have liquidity (ex. work reimbursements being slow, a paycheck snafu, etc.)
- Contribute 15-20% of your income to retirement using 401K or IRA or a combination thereof.
- Ease up on your not-spending some.
- Get a bigger emergency fund that will cover you in case of a job loss. Feel free to invest this in IRA Roths since you can withdraw principal without penalty (it doesn’t need to be in stocks!).
- Pay off some of your other debt if there’s a lot of it, especially if your monthly payments are high. (This helps your cash-flow.)
- Ease up on your not-spending to more middle-class levels.
- Get a secondary taxable emergency fund that will cover you for a while in case you want to find yourself one of these days. (Again, IRA Roths are a good choice for starting.)
- Start stuffing money into easy retirement advantaged vehicles, like your 401k/403b/457/IRA
- If you have kids and will need to pay some of their college expenses, 529s are nice.
- Start looking into fancier vehicles like backdoor Roths (because at this point you’re probably unable to contribute to a regular IRA) or super-mega-backdoor Roths.
- Hire a tax adviser to tax advantage your assets in ways that legally cheat the government.