Should I contribute to my 401K?

I spoke to “Steve”[1] recently.  A nice young man in his early 20’s that recently started a new job in biotech.

 Steve is a very bright and hard-working son of a client of mine.  These last several years, I have been helping the next generation start off on the right foot financially.  Some are in a better place than others.  Mostly, because of debt.  One of the worst areas I see are student loans.

When one has 100k, 200k, or even 300k in student loans, the road to financial freedom can be very rocky.

Steve’s question to me was pretty straightforward. “Should I contribute to my 401k?”

Generally, here is where I put on my CFP® hat and ask a few questions.  Since Steve is single, I asked the following:

1. Do you have any debt?  Student loans, Credit cards, or other loans?
2. Do you have any money left over from each paycheck?
3. Is there a company 401k match?
4. Do you have an emergency fund with at least three months of expenses set aside?
5. Are you currently putting money toward retirement or other savings?
6. Do you have a large purchase or expense coming up in the next year or so?

After getting some information, I learned the following:

1. Steve owed about $60,000 on various student loans.   (I knew he had loans but wasn’t sure on the remaining balance)
2. He had no other debt other than a car loan of $450 a month
3. Steve did not have an emergency fund
4. Between rent, his car, and other expenses, Steve wasn’t saving anything each pay period
5. There was a 6% company match so for the first 6% Steve put in, the company matched that 100%.  Example, Steve’s 6% is $4,500, his company matches $4,500. Nice
6. Steve wanted to buy a condo in a year with a price of about $400,000

Steve provided me with what he thought his monthly expenses were. Doing some quick math on what his take home income was, and what his expenses were, it appeared, he could have been saving an additional $1,000 a month.

So, where did that $1,000 a month go?  In some sort of black hole where money evaporates into? 

I gave Steve a more detailed, online monthly expense form to work with and explained by providing more accurate numbers, we can determine where the money is going.  In my experience, we sometimes find it might just be going to eating out, clothes, events etc.

This doesn’t mean one has to stop living, it just means we need to know so we can plan better.

At first glance, we might think Steve has a lot in student loans.  He does work in biotech and earns a very good salary for just coming out of college.  On top of that, most biotech companies offer good benefits (like the 6% 401k match) as well as stock options and other incentives. 

Owing 60k in student loans when one is in biotech is very different than when one is a dishwasher sitting with a lot of debt.  Over time, Steve’s income will rise, and the loans are relatively reasonable with his ongoing income potential. (We still should look at these loans to see if a different strategy for paying them off is warranted)

In Steve’s case, one of the things that stood right out to me was that he wanted to buy a small condo within the year.  A short term, high-cost goal.

If Steve didn’t have this goal, my answer on the 401k contributions might be different.

The other issue is the condo price.  Is this what an average one-bedroom condo in his area would cost or is it on the high (or low) end.

Getting a good handle on money coming in and money going out is a great first step in determining if other goals (like the condo purchase) can be within one’s reach.

As I’ve always said, financial goals shouldn’t be looked at in a vacuum.

Unless one takes a holistic approach, we really can’t be certain if all our goals will come to fruition.

I haven’t finished working the numbers on if or how much Steve should contribute to his 401K.

Generally speaking, not contributing up to the company match is leaving money on the table.  In the example above, that would equate to $4,500.

When deciding whether you should be contributing, if your debt level seems reasonable, you aren’t on target for retirement, you have an emergency fund with about three months of expenses set aside, then contributing to your workplace retirement plan can be a wise move.

If there is a company match, all the better.

If you have a short-term goal such as buying a house, you will need to look more closely at things to determine how much should go toward the home purchase.

As always, when making big financial decisions, it is always best to speak with and take the advice of a Certified Financial Planner® practitioner. Any questions, we are here to help you figure it all out.

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A bit behind on saving for retirement? check out my article…  Over 50? You may be eligible for a Catch-Up contribution”

All the best.

Rick Fingerman, CFP®, CDFA™, CCPS®

Rick@PlanWithFPS.com

617-630-4978

Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.

[1] Steve.  Not his real name