While many investment advisers recommend that all workers contribute at least 10 percent of their paycheck to a 401k plan, it is possible to invest too much in the plan. If contributing to your 401k plan interferes with your ability to build an emergency fund or meet your regular obligations, you might want to scale back the percentage you put in, at least temporarily.
Building an Emergency Fund
Building long-term wealth for retirement is important, but it is just as important to have an emergency fund. Most experts recommend that you have a minimum of three months worth of living expenses set aside in a safe investment like a savings or money market account. If you can put away nine to 12 months worth of expenses, even better. If your current level of 401k contributions is impacting your ability to build the emergency fund, scaling back until you have your emergency cash in place makes sense.
Understanding Your Company Match
A company match provides one of the strongest incentives for contributing to a 401k plan, but the structure of your company match could mean you are shortchanging yourself by contributing too much of your salary too soon. If your company front-loads its matching funds, you could lose out on some of that money if you reach your annual contribution prior to year’s end.
If you contribute so much of your salary that you always reach the maximum contribution limit before the end of the year, you should check with your human resources department to see if the employer contributions are front-loaded.
To see the impact of investing too high a percentage in your 401k, consider an executive who makes $20,000 per month and contributes 20 percent to his 401k with a 5 percent company match. That executive would reach his $16,500 limit in May, and the matching contributions would be limited to $4,500. If that executive scaled back his contribution percentage to 7 percent, he would not reach his annual limit until December, and he would get the full company match of $12,000, a gain of $7,500.
Neglecting Your Current Needs
Chances are you have both short-term and long-term investment goals to worry about. Contributing to your 401k helps you with your long-term retirement goals, but it does nothing for your short-term goals. If you find that you are neglecting your short-term needs in favor of retirement planning, you might want to allocate your resources more equitably.
Short-term goals can include such things as saving up money for a new car so you will not have to take out a costly loan, or saving for the down payment on a first home so you will not be saddled with a large and potentially unaffordable mortgage. Reaching your long-term retirement goals is important, but using your money for shorter term planning is important as well. It does not make sense to fund your long-term goals at the expense of your current needs.
Heavily Weighted Retirement Plan Contributions
If you have been contributing heavily to your 401k and maxing out your IRA contributions, you might find that your assets are heavily weighted toward tax-deferred retirement plans. While it is a good idea to put away as much as you can for retirement, you need to build personal non-retirement assets at the same time.
Building non-retirement assets can be even more critical if you plan to retire before you reach age 59 1/2. You cannot start taking ordinary distributions from your 401k until you are 59 1/2, so if you plan to retire early you will need funds to tide you over until you reach that age. If the bulk of your retirement assets are in retirement plans, scaling back those contributions and building up your personal assets makes sense.