Ask the grumpies: Save in a 401k on a low income?

Leah asks:

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)?

  1. Contribute your 401k up to the match.  Take the money out at a 10% penalty if (2) or (3) are problems.
  2. Pay off your high interest debt and do not create any more of it.
  3. 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.)
  4. Contribute 15-20% of your income to retirement using 401K or IRA or a combination thereof.
  5. Ease up on your not-spending some.
  6. 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!).
  7. 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.)
  8. Ease up on your not-spending to more middle-class levels.
  9. 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.)
  10. Start stuffing money into easy retirement advantaged vehicles, like your 401k/403b/457/IRA
  11. If you have kids and will need to pay some of their college expenses, 529s are nice.
  12. 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.
  13. Hire a tax adviser to tax advantage your assets in ways that legally cheat the government.


27 Responses to “Ask the grumpies: Save in a 401k on a low income?”

  1. Leah Says:

    Thanks! I read a few financial blogs, and a lot of people advocate maxing out retirement vehicles. But doing so would be a lot for me! This answers my question on how much is enough. I like the idea of thinking, too, about how much we spend now in relation to retirement and the amount needed then. I think I know this and forget this regularly when I imagine how much money we’ll need.

    Also, do early retirement folks save in a 401(k) or similar vehicles? Cursory research indicates sometime after 55 as long as you’ve stopped working. Looks like a Roth IRA is 59 1/2 for earnings but can withdraw contributions at any time. So do FIRE people save in several vehicles and let each one kick in at a different time?

  2. yuppiemillennial Says:

    I’d add one re: the question of over-contributing. Some 401k plans allow you to take out a 401k loan. This can give you access to your 401k money in case of an emergency, though will need be paid back in 60 days if you leave your employer (so not a good back up for unemployment). Interest goes back to you and no early withdrawal / penalty fees (though a small amount of double taxation on funds going toward the interest).

    • chacha1 Says:

      I know someone who lost her job (had to give up the job, they would have taken her back if they could) after being kicked in the head by her horse. She had taken out a 401(k) loan for some purpose of which I am unaware. Even though she was on disability, she had to pay back the loan. It was a grim situation.

      Americans have a tendency to go “lalalala that can’t happen to me.” The most likely way for someone of working age to be rendered unable to work is an accident. If disabled by an accident, you are still on the hook for every obligation you contracted while healthy. 401(k) loans should never be thought of as anything other than a last resort.

      • yuppiemillennial Says:

        Was your friend not able to take the 10%+income tax penalty? I had thought that early withdrawal fees were what happened for 401k loan defaults. Obviously, still not ideal, but slightly better than having to pay the whole thing back.

        That said, I totally agree you shouldn’t rely on 401k loans. I was mostly trying to convey that, if the only reason someone wasn’t putting money into their 401k (especially up to the match) was because they thought of retirement accounts as impossible to access before 59 1/2, then maybe knowing 401k loans exist (i.e. some theoretical method of access) might push them over the edge into contributing.

  3. Leigh Says:

    I would also advocate for using a Roth 401(k) if you’re in the 15% tax bracket and you have access to that. You’ll still get matching money if you contribute to the Roth 401(k), though the employer money will go into a Traditional subaccount and yours into a Roth subaccount.

    You can *always* take out your contributions from a Roth IRA with no penalty, just not the earnings. So I would advocate contributing to a 401(k) enough to get the match and then put whatever more you can save for retirement into a Roth IRA. You most likely only need to save 10-20% for retirement if you want to retire at age 60, so I wouldn’t worry so much about maxing out your 401(k).

  4. SP Says:

    This year we are saving “only” about 20% in retirement accounts in order to enable other cash-based priorities. It feels weird, because for most of my 20s I put the majority of excess money in retirement. Now we have more room for retirement savings, more overall income, but a few other priorities.

    I agree with this list. I don’t know if I want to work until I’m 60 (i certainly want the option not to), so we probably should save more in the long run, but the high cost housing in this area feels like a bigger risk to me. Mathematically, the rate is too low for it to make sense to pre-pay the mortgage, but it makes sense to me for a lot of reasons you guys already get.

  5. chacha1 Says:

    Retirement savings is another area where I got really lucky. I graduated from college in 1987 and by 1989 was working for an employer who offered a 401(k) plan. I’ve always contributed. (For eight years I worked in an otherwise-horrible office that paid really well, including a generous profit-sharing contribution. They put in *far* more money than I did.) I wholeheartedly agree with the Grumpies that if you can afford to have money locked away, always contribute at least as much as will get you a company match.

    And I agree that if your cash flow is very precarious, keep your savings liquid. (This is, of course, also where you should be minimizing expenses as tightly as you can.) An emergency fund is not for a new car when the old one still runs … it’s for a new tire so that you can still drive to work.

    I don’t know anybody who has saved “too much” for retirement. I do know a lot of people who bought more car (or house) than they could afford, and now think their retirement savings has to cover the cost of those luxuries, and are blindingly stressed-out about it.

    • Leah Says:

      Mostly, it’s “I could max out my 403(b) but is that recommended if doing so would be ~50% of my liquid monthly cash?” I think the answer is yes. I just get paranoid about all of this; it’s a world I don’t understand.

      We save a good chunk for retirement. We also save a good chunk in liquid cash because we don’t have housing expenses, but I’m nervous about tying those up in retirement, so I’m always futzing around with the numbers. I want to be able to buy a house (or at least not worry about affording a place to live) should we have to leave our jobs and thus lose our housing.

      • nicoleandmaggie Says:

        I think you just need to think through emergency scenarios and how much cash on hand you need for them, then run numbers on what % of your income you should be saving for retirement given your plans and so on.

        And remember, if you have over-saved for retirement, you can always stop saving later. So if you put that money away for retirement now, you can stop putting so much money away (for example, just contributing to match) when you decide to save up for a down payment. (And the Roth has some flexibility for housing.)

        Presumably if you quit your jobs, everything will change, including your income (which will probably increase!) So you’ll be running entirely new numbers.

      • Leah Says:

        Good lord, yes, I hope my income increases if I leave my job :-) good point there. I need to do new numbers and see where we’re at, %-wise. We’re maxing out the Roth IRAs (already have for ’16) and contributing above the match for sure with the 403(b)s. I should ask what the match even is. I just know we’re above because I check every summer with my HR lady to make sure we stay above it. The match is a % of our salary, so the #s change as our salary increases.

  6. gradstudent Says:

    What do you recommend for grad students? I’m in an annoying position, because I’m a MD/PhD student making a student stipend (although thankfully, no debt), but I’m not eligible to save for retirement (and am living exactly at my means). My coworkers make fun of me because I’m thinking about this in my 20s, but I see my younger sister in her real world job putting money away. I won’t be out of this quagmire until 4 years from now, or so, and then I have residency and possibly fellowship, so I’ll be in my mid-late 30s until I am able to really save.

    I try to save a little bit every month, but it’s not much and I’m super worried about playing catchup. Any suggestions?

  7. Angela Says:

    I was reading an article recently (wish I remembered where) that said that you may not be able to only take your contributions out of a Roth IRA if you need to take money out. The example it used was that if you put in $4k and the total value was $5k, you would think you could take out $1k of contributions without paying a penalty, but that the IRS would consider the withdrawal 80% contribution and 20% earnings (based on the percentages of contributions and earnings in the account). Anyone know if that is true?

    • Rosa Says:

      I’m pretty sure that only is true of some of the contributions were a rollover from a traditional IRA. The IRS says: “If you receive a distribution from your Roth IRA that is not a qualified distribution, part of it may be taxable. There is a set order in which contributions (including conversion contributions and rollover contributions from qualified retirement plans) and earnings are considered to be distributed from your Roth IRA. For these purposes, disregard the withdrawal of excess contributions and the earnings on them (discussed under What if You Contribute Too Much? in chapter 2 of Pub. 590-A). Order the distributions as follows.

      Regular contributions.

      Conversion and rollover contributions, on a first-in, first-out basis (generally, total conversions and rollovers from the earliest year first). See Aggregation (grouping and adding) rules, later. Take these conversion and rollover contributions into account as follows:

      Taxable portion (the amount required to be included in gross income because of the conversion or rollover) first, and then the

      Nontaxable portion.

      Earnings on contributions.

      Disregard rollover contributions from other Roth IRAs for this purpose. ”

      I could be reading the directions wrong of course, but this seems in line with the rules I was taught, too.

  8. First Gen American Says:

    You know, when I was in college, I worked at the Marriot as a banquet waitress. I made $8 an hour (which seemed like a lot at the time). Anyway, they offered a 401K plan but I didn’t work enough hours to qualify for it and it bummed me out. Even at that income and being still in my teens, I would have totally done it if I qualified because of the company match.

    For me it was pretty hard to say no to free money no matter what my income was. Free money has always trumped all other savings goals.

  9. Ask the grumpies: Getting started with money | Grumpy Rumblings (of the formerly untenured) Says:

    […] of your overall personal portfolio (not just your retirement investments).  Here’s an ordering strategy of how you could choose to use your money. In terms of college savings and financial aid, you […]

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