Never Stop Contributing to Your 401(k)
There are some people who suggest that it's OK to stop contributing to your 401(k) plan if you experience a financial crisis. However, here's why you should always—and I mean always—contribute to your 401(k), even if you are falling behind on your bills. Never stop contributing to your 401(k) if there is any way you can possibly help it, no matter how bad the financial crisis may be.
Tapping Into 401(k) Balances
The ease with which people can access their 401(k) money, and the 10% penalty tax with which many get slammed, is one of the reasons the American retirement system is in jeopardy. In the old days, you couldn't raid your pension fund no matter how dire things became. Now, people turn to their accounts, always banking on being able to replenish the funds at some point in the future. It's an absolute tragedy.
Here is why to keep contributing to your 401(k) plan even if you are experiencing financial hardship:
Contributions Are Often Tax-Deductible
In other words, your taxable income is reduced, so you end up paying less in tax. If you instead choose not to put those dollars aside, the Federal and state governments are going to take a bigger chunk of your pay in income taxes. Not only will you end up with less money in your retirement account, but you'll also end up with less cash in your hand today. It's sort of like killing the chicken for meat now when you could live off the eggs for a much longer time.
Many Employers Match Contributions
If your firm were to give, say, a dollar-for-dollar match on the first 3% of salary, someone making $40,000 per year could get an extra $1,200 in pay—tax-deferred—simply by making contributions to their 401(k). If you stop, not only are you going to pay the higher taxes we discussed just a moment ago, but you are going to forfeit this money forever.
Protection Under the Law
If you are unfortunate enough to have to declare bankruptcy, most courts will protect your retirement accounts, including your 401k. That means that the money that has been put aside will stay there while the rest of your assets are liquidated or reorganized. If you are really in trouble, you should want to put as much as possible away in this relatively safe place, beyond the reach of many creditors. That way, if you were wiped out, you have a great chance at starting over ahead of the game with investments pumping out passive income for you.
Long-term Tax Advantages
Over long periods of time, the tax advantages enjoyed by a 401(k) can result in far more wealth than if you had held your stocks or mutual funds in a brokerage account. If you stop contributing to your 401(k) plan, you lose all of the time value of money compounding that would have gone to you.