by Eileen Ambrose
July 6, 2008
Rising gas and food prices and a stock market slump are starting to prompt people to reduce or suspend contributions to their 401(k) retirement plans.
Charles Schwab, for instance, said that more than 7 percent of participants in 401(k)s it administers reduced or stopped their contributions in the first quarter of this year, up from 5.8 percent the year before.
Putnam Investments' survey of plan advisers in May found that one out of five participants had reduced 401(k) contributions this year. And more than 9 percent of workers newly eligible to enroll have decided to postpone participation.
"People really do have the message that retirement is important and they need to save," says Anne Coveney, a managing director with Putnam. But "there is so much pressure on them right now, some workers are starting to turn to their 401(k)."
The large majority of workers in these surveys are keeping up with their contributions, and 401(k) administrators, such as T. Rowe Price Associates, Vanguard Group and Fidelity Investments, have not noticed any drop in savings rates. But that could change if the economy, as some economists predict, heads into a full-blown recession next year.
No financial planner, or me for that matter, likes to see workers cut back on retirement savings when they might not be salting away enough already. But for some people living on the edge, saving for retirement is impossible given rising costs and limited means. I'm reminded of the story recently about a Pennsylvania woman who had to choose between paying her mortgage or heating her home in the winter. She chose warmth - and is now losing her home.
Fortunately, most of us aren't in such dire straits. We can forgo HBO or other small luxuries if food and gas prices continue to escalate. Reducing retirement contributions should be one of the last steps.
"What people need to think about is if they believe there is a permanent rise in the cost of gas or a permanent rise in the cost of food, they need to find a permanent solution. Reducing 401(k) contributions is not a good solution. You are setting yourself up for impoverishment later on," says Stuart Ritter, a T. Rowe Price financial planner.
A more permanent solution is to look at where your money is going now and to find ways to cut expenses. Consumers already are cutting back on the more obvious expenses - vacations and dining out.
"When money is tight, frankly, it takes you back to those very basic questions about budgeting, managing cash flow and making distinctions between wants and needs," says Michael Kitces, a financial planner with Pinnacle Advisory Group in Columbia.
Even by eliminating all discretionary spending, you may still have a cash flow problem. If you conclude that you cannot afford to keep up with your 401(k) and pay the bills, there are ways to reduce contributions without throwing your retirement out the window.
The worst move you could make is to pull money out of a 401(k). You will owe regular income tax on the cash and possibly an early-withdrawal penalty. And once money comes out of a 401(k), it is no longer protected from creditors, says Dean Kohmann, vice president of 401(k) Plan Services at Schwab.
Instead, you are better off reducing your contribution to the point where you still receive the full employer match.
Workers typically contribute 8 percent of pay to the 401(k), according to Hewitt Associates. The usual employer match is 3 percent of your pay if you kick in 6 percent. That's a guaranteed 50 percent return on your money.
Once your finances improve, you might have to boost your contributions to a level higher than before so you can catch up on lost savings, Ritter says.
Odenton financial planner Jim Ludwick says he has advised clients with serious debt problems to reduce their 401(k) contributions. The clients still contribute enough to get the employer match. The dollars no longer going into the plan are used to pay off high-interest-rate credit card debt, he says.
It can take four or five years to pay off deep debt this way, and none of his clients have reached that point, he says.
Once they do, "we're going to have to analyze how much more they will have to put in [the retirement plan] and how much longer they will have to work," Ludwick says. By lowering their contributions to pay off debt, these clients might have to work an extra year or two before they can retire, he says.
Last, the downturn in the stock market might also have contributed to the decrease in 401(k) contributions. Workers looking at their quarterly 401(k) statements wonder why they should keep investing when their account balances remain flat or go down, says Schwab's Kohmann.
In that case, it is time to review your holdings.
Make sure you have the correct asset allocation - the percentage of stocks and bonds in your portfolio - based on the years you have left to invest. Your holdings in stocks and bonds must also be diversified, so you're not, say, invested too much in one type of stock. And at least annually, you need to rebalance your portfolio to return it to the proper allocation. These steps can help you weather a bearish market and keeps you investing so you benefit if the market suddenly rebounds.
Too much work, you say? Then switch to a retirement target-date fund, if your plan is one of the many that offer it. You choose a fund based on the date of your retirement, and a professional money manager handles investment choices and rebalancing for you.
