Are 401(k) and 529 Plans a Good Idea When You’re In Debt?


Note: This is a post from Joan Concilio, Man Vs. Debt community manager. Read more about Joan.

As part of our quest to come up with $7,100 for the IRS before April 15, my husband and I decided to cash out a 529 account we’d set up for our daughter’s education expenses. We pulled $2,500 out of that last week.

If you’re not familiar, 529 plans are kind of like 401(k) plans for education expenses. So, much like if we’d cashed out a 401(k) account, this $2,500 will be subject to taxes now that we withdrew the money.

I’ve mentioned before that 401(k)s, 529s and other plans with numbers instead of names aren’t my family’s preference for savings or investments. But why would I take a tax hit to help pay for the taxes?

Well, I’m actually not opposed to investing. I’m certainly not opposed to saving for future expenses. But there are four main reasons why managed savings vehicles like these aren’t right for us, and each of those raises a question I want to challenge you to answer about your own savings plan.

1. I like my money in my hands.

One thing I’m opposed to is having money tied up in inaccessible ways when I have a need for it in the short term.

We fully plan to be able to help our daughter, Sarah, with any higher-education costs she might have.  In order to do that best, though, we need to be debt-free.

$2,500, in the scheme of Sarah’s potential college or trade-school costs, isn’t much. But it’s a third of the amount we need to avoid taking on debt to pay the IRS. In this case, the money in my hands has more long-term benefit, especially when it’s a (relatively) low dollar figure.

At the financial stage we’re in, liquid assets are key. We have an emergency fund in a savings account linked to our checking account, and that’s great – because should we need the money, we can get it quickly.

When we’re debt-free, our emergency fund will likely get much larger. Our “savings” will become separate from it in many ways. Even so, we’ll want to keep a significant amount of money available to us without penalty. We like having our money in our hands. The security of this is worth the potential “loss” of some interest or investment return.

That’s why we were so glad to cash out the 529 plan money. It was a way to get that money working for us in the way that makes the most sense now.

Ask yourself this: Of the money you have in savings – whether for a planned event, such as education or retirement, or for an emergency – are you comfortable with the amount you have easy access to? If not, what can you do to bring that amount more in line with your goals?

2. Even a good investment is costing us.

Right now, I have $29,316.52 in my 401(k) account, and Chris has $15,000.42 in his. That’s more than $44,300 that we have in savings. But we can’t get to it – unless I quit my part-time job or he quits his full-time job, there is no way for us to touch that money. Even if we quit, we’d pay a hefty penalty to get access to that $44,000-and-some.

If I had it to do over again, I would never have opened them. Again, I’m not against retirement savings. I’m not even against INVESTING as a method of retirement savings.

But right now, I have $44,000 earning an average 8% annual rate of return, and about $59,000 in consumer debt costing me an average of 14% annually in interest.

You read that right. I’ve got a pretty good set of investments – but I’m not increasing my bottom line with them, because they’re outpaced by the debt interest we’re paying.

At this point, I can’t do much “about” this except complain. I’ve made my choices and I have to put up with them, so I try to keep even that to a minimum. However, I’m very glad we decided two years ago to stop contributing to these plans. While the money that’s there is there, I’m not throwing MORE money into an 8% return to the detriment of paying off the 14%-ish debt. (We have no company match, but I would agree with Dave Ramsey on this – I wouldn’t contribute right now even if we had a match. You don’t invest until the debt’s gone – period – in my opinion.)

 Ask yourself this: Are any investment contributions you’re currently making offsetting any interest you’re currently paying? Even if you plan to contribute again in the future, should you decrease or stop your contributions for now?

3. I like focusing on one thing at a time.

I am whatever the opposite of ADD is. My personality is to hyper-focus, to want to do something at the exclusion of everything else. I’ve learned to make that work for me. And that means that if my focus is on paying off my credit-card debt, I cannot take on another money “thing” at the same time.

Our plan is to pay off what started as $90,000 in consumer debt by the end of 2014. Next, we want to save up for and purchase a car in cash. After that, we want to get some work done on our home, and increase our emergency fund and checking-account reserve, and help pay for some of our daughter’s future expenses, and save for our own future needs.

Many people could and would work on these things simultaneously. For me, that’s distracting at best. At worst, it would lead me to get frustrated – because I like to have ONE goal and be making noticeable progress toward it – and if I didn’t feel good about my progress, I’d probably give up. It’s happened before.

My contention is that the dollar figures don’t change; this is a matter of mental motivation. So we’re choosing to let “savings” beyond our current $1,700 emergency fund be a separate task, to be tackled once the consumer debt is gone.

Ask yourself this: Do you work better tackling one or two key financial areas at once, or slowly addressing several simultaneously? Are your current actions in line with that personality style? If not, would you be better served paring down – or expanding your focus – and how can you take action to do so?

4. We plan to remain debt-free for life.

This is what makes the one-thing-at-a-time plan possible. Right now, we pay $2,500 or more a month toward our consumer debt. When that’s paid off, what happens?

  • Putting $2,500 in savings for 1 month gets us right back to where we started, with the $2,500 we cashed out from the 529 plan.
  • Putting $2,500 in savings for 8 months gives us enough to pay cash for the type of car we’re looking for (easily).
  • Putting $2,500 in savings 10 months gives us the ability to make a wonderful gift to our daughter as she begins her adult life.
  • Putting $2,500 extra against our mortgage each month gives us a chance to take 21 years off the life of that loan, which would make us mortgage-free less than 10 years from now.

Add those up. In less than two years after we become consumer debt free, we have the ability to accomplish more financially than a lot of people will in their lifetimes. And in less than 10 years, if we want, we have the ability to be in the 1/3 of Americans who own their home free and clear! That will drastically change the amount of money Chris and I need to “retire” – which gives us so many more options beyond a traditional IRA or 401(k).

But all of that is contingent on TAKING ON NO NEW DEBT. And since we won’t be doing that, we can save in some BIG ways. That’s our “investment” right now – we’re invested in the idea of being and staying debt-free.

Ask yourself this: If you’re not yet debt-free, do you have a clear vision of what you’ll do with the money you WERE paying when you are? If you’re already debt-free, are the things you’re doing with your money in line with your long-term goals?

I don’t expect that this system works for everyone. I can’t say often enough that personal finance is personal – it’s about finding what gets you in the place you most want to be.

I also don’t expect that we’ll stay investment-free forever. When we have a significant amount of financial freedom, we will likely use smart investments to help grow the money that we’re not using for other goals.

But I’m curious if you’ve examined your own investments or savings vehicles in detail. My fear is that most people contribute to their company 401(k) “because that’s what you’re supposed to do.”

Be willing to think differently. 

And please, share your savings or investment system in the comments!

84 thoughts on “Are 401(k) and 529 Plans a Good Idea When You’re In Debt?”

  1. I disagree with you on the element where you said you wouldn’t contribute to the 401(k) even if you had a company match. That’s free money that you’re saying no to. Just because you can’t use it today doesn’t mean you should turn it down. The bottom line is that a company match increases your net worth. Even if your number one goal is to reduce/eliminate debt, a household should always have focus on increasing net worth (at least through working years), and if your company is putting money out there for you, it’s a direct opportunity to increase your net worth at the fastest rate possible. If, as you said, you have no company match, then I have no problem with your strategy.

    1. See, in my case, I’d need a HUGE company match for that to increase my net worth. My estimates above were conservative – they considered my average APR – but in my previous posts I’ve broken it down and what I’m really using that money for is to pay down our $18,000 balance on a card at 22.99% APR.

      If I took the $1,000 over the minimum that I pay on that card every month and contributed to a 401(k) earning 8% return (or even 10%), even with a full company match of the $1,000 a month (which would be incredibly high – most companies wouldn’t come close to that), that $2,000 at 8% would not have me “up” at the end of the year more than the $1,000 on the card would have me down.

      Like I said, that’s not true for everyone. For many people, it WOULD increase their net worth. But I could have a company matching TWICE my contribution (if you know of one, tell ’em to call me!!) and still be hurting my bottom line each month.

      I think it’s also very relevant that we’re talking about a specific four-year period here (from the start of our debt-payoff plan in 2011 until approximately the end of 2014, when it’s gone.) Let’s just say 2011 and 2012 weren’t years I’d have wanted extra money in my investments… and now, with less than 2 years to go, I’m not motivated (I talk more about motivation in another comment) to want to make a drastic change now!

      That said – you hit the key point that I mentioned, which is – WHAT INCREASES YOUR BOTTOM LINE? In my case, a match still wouldn’t, but if your situation is different, that’s a valuable question to ask yourself!

      1. Joan – I’ve conceded the emotional issues, but need to keep the numbers correct.

        On the matched $1000, you have $2000 in the 401(k). If it earns 0%, you still have a $1000 gain from the match. The $1000 sent to the card will save you $230/yr. It’s still $1000 vs the $230. Can’t leave that 22% interest debt floating forever, a few years can wipe out even the 100% match of course.

        2011 S&P return was 2%, 2012 was 16%, an average 9% I’d actually be happy to have for the rest of my investing life.

        I’m following all the comments here, and hoping I’m not sensing an irrational fear of investing for the long term. For most people, the ‘locked-away’ aspect of their 401(k) is a benefit, a protection from themselves. As long as the 401(k) is low cost and has decent investment options, one shouldn’t confuse the account (The pretax ‘box’) with the investments inside. Once you have any long term savings, it needs to be invested. The same asset allocation decisions appear in your regular accounts as in the retirement accounts.

        1. I’m sorry, but I’m afraid Joan has a point on the company match, and it’s because of compound/compounded interest, and taxes.

          If you put $1K into a 401k with a match, in ten years it’ll be worth $5200. If you leave $1K (actually $800 since you have to pay taxes) in at 23% CC interest, your debt will increase to $6300 in the same10 years. To add insult to injury, when you withdraw from the 401K, you’ll have to pay the income tax on the whole amount, so you’ll have closer to $4100 after taking out 20% for taxes.

          Of course, if you expect a windfall next year (inheritance, a bag of money falls off a truck, lottery), the calculations change.

          1. Dan, don’t be sorry. I’m a numbers guy, and the great thing about numbers is there’s no arguing. There’s no ‘correcting’ you either.
            If one has such high interest debt, and funding the 401(k) will stretch the payoff that far out, just pay the cards 100%. No 401(k). At 23%, I’d be eating home, rice and beans till it was done. No beer, no fun, just pain until it’s gone.
            But, if the plan for payoff were short, say 3 years, and the matched 401(k) put it to 4 or 5, do the math and you’ll see the match comes out ahead.
            My sisterinlaw was struggling to pay off a credit card bill, and not getting her match. I lent her the money at my equity line rate (2.5) and gave her a plan. The saved interest becomes her matched deposit, and when the card’s all paid in 5 years, her retirement plan is jump started instead of empty.

  2. I’ve never had the luxury of a company match with my 401(k), but that is a powerful motivation to invest with one. That said, I’ve stopped new investments into my 401(k) while I was getting out of debt and building assets in other places.

    Right now, I’m building P2P lending assets, aggressively paying off the mortgage on our rental home, and building a rainy day fund (we will transition renters here in a few months, and that could cause some big expenses). Once my rainy day fund is where we want it, we will work to even more aggressively paying off our mortgage with even higher principal payments. I want no more debt in our life of any type!

    1. Mike, I really look forward to being in the point in my life where you guys are! That is my dream right now – but a dream I’m actively working to bring to fruition. I think your investment strategy also most closely matches my ideas – as I read from your comments over time, you invest in PEOPLE directly where possible, your strategy is diverse, and you work to have plenty of liquid assets.

      Those are all things that matter to me and that I find motivational when I talk about building assets with as much fervor as I’ve been tackling debt.

      1. Joan, I think you give us too much credit, but thanks! I think your characterization of our investment strategy is right, mainly because I’m looking to be in a good position 4-5 years from now as a bridge from one career to whatever is next.

        What I like about you is that you’ve figured out the psychology of debt– to heck with math when you’ve got this albatross hanging around your neck, right? I can give all sorts of reasons why I should just accept my low-interest mortgage, but I JUST DON’T LIKE IT hanging over my head!

  3. Interesting strategy. When I was paying off my $50k worth of debt, I still invested money in my 401k. The reason they put penalties on it is because it is to discourage pulling the money out. Now that I am consumer debt free, I am really happy that I invested my money. I came out on track for retirement. No matter how hard you try, you can’t bring back the lost compounding interest and you can’t predict the future.

    1. Yep – I don’t like anything that takes my money and puts penalties on it. That’s not coming from a “math” perspective – I understand how large fund management programs work and that people making withdrawals all over the place would break the system pretty quickly. (Oversimplified, but I get the idea behind it.)

      But that doesn’t sit right with me personally. It’s a choice – for a lot of people, it’s one that makes sense for them. I just hate seeing people doing things by default instead of sitting down and considering if that works in their life… because they’re NOT the people who come back and comment and say “I am really happy I invested my money.” I can tell just by you saying that, that you gave it some thought when you were contributing, you know?

      So that’s great – I hope more people will do the same!!

  4. A good posting, it is definitely all to easy to lose focus and becoming debt-free should be the No.1 goal for almost everyone.
    I agree with Money Beagle, but only to a limited extent. Yes, don’t say no to free money! However unless the 401k match is quite substantial, and the rate on your debts higher than the rate that the investment pays, I would think that you still be might be better off paying debts. That’s purely financially, even before taking into account the motivational effect of seeing your debts melting away in the intense glare of your single-minded focused efforts.
    Once you are debt-free, if you want to keep control of your money, you can still take the company match, thank you very much, then cash in the 401k and pay the 10% penalty and you will still be ahead.

    1. Martin, that’s exactly what I’m getting at – I’d need SUCH a high match to make even the math work, and even if it did, that would not personally be motivational to me in the way single-minded focus is. And that’s what I’m really about – the motivation!!

      I was interested in your point about taking the match and later cashing in. Certainly not the most extreme idea I’ve ever heard! In our case, unless we quit entirely the jobs these plans are tied to, we CANNOT cash out (due to structure of our plan), but if we did, we’d pay a 30% penalty/tax in total. And guess what? It’s POSSIBLE that we’d do that. Not certain, but it’s not something we’d write off! Would all depend on circumstances at the time! (Now people will really be ready to burn me at the stake!)

  5. I am with you and Dave Ramsey on this one with regards to investing while paying off debt. The only problem is that my company (a non-profit) requires me to contribute 5% of my income into a 403b (very similar to 401k). I do not have an option on this, it is written into my contract. In return, my company contributes an amount equal to 10% of my income into a 401a (also similar to 401k). So I get a two-for-one match. The company does not match above this, however. This means that each month I have $391 less to pay towards debt. It is slowing me down, but I should still be able to completely wipe out my consumer debt by the end of this year (only $18,794.28 to go).

    1. Paul, I’ll say this: If you have to get stuck in a situation like that, at least yours ends up being what I’d say is “generally positive” – can you imagine the places where that requirement isn’t matched by the two-for-one deal? Ugh.

      I’m with you, though, it IS a slowdown, and it’s a bummer not to have a choice in the matter.

      And GOOD FOR YOU for pressing on and being within sight of the goal. That’s amazing – I can’t wait to celebrate at the end of 2013!!

  6. The Plaid Cow

    Though I want to be out of debt, I can’t justify stopping the 401k contribution (with company match) to move the debt payoff date up a few months. The 100% company match, discount on taxes and 8% average return outstrips the 7.2% (and dropping) average interest rate on the unsecured consumer debt we still have. (I did have the contributions stopped for about 2 years, but during that time, the extra money we should have had coming in, just disappeared into the ether.)

    1. I think you hit a big reason NOT to do what I’m saying – if that money isn’t immediately going toward any debts with higher interest rates, it’s not helping your bottom line. (And I hear you – we have certainly “been there, done that” too.)

      I think if our APRs were low, I might feel differently (more like you’re saying), but it’s hard to say… I’ve said in a few comments here about motivation, and that’s really what it comes down to. If I had low-APR debts, would it still be motivational to me to put every cent at them? I don’t know? (And in good news, I’ll never find out, because there’s never gonna be another one – that’s my vow to myself!)

      1. By passing through a new line of credit, I managed to drop $8K of our debt from APR 20.99 down to 9.99 with no balance transfer fees. I also have some balance transfers that have been sitting around much longer than they should have at 2.99 – 4.99%. Is there no method you could use to drop the APR to around 10% so you could put an extra $200 per month towards the debt?

        Also, since I just looked at my 401K balance, if I do get 8% per year, it will double three times before I am ready for retirement (at 63) and will be worth about 1.75 million. (And that is if I invest nothing else.) The 50K of debt does bother me, but at least I feel we are on a much better trajectory right now.

  7. A bird in hand is worth how many birds in a bush?

    Debt can be written off savings can’t.

    Don’t be silly with YOUR money.

    To answer you question, NO 401K plans are a terrible idea if you are in debt because if you loose a debt law suit then boom there goes your money.

    1. Darnell, I hadn’t really thought about that – we’re not in that position (thankfully) – but it’s certainly an interesting reminder!

    2. There is SO MUCH terrible advice flowing around in these comments. Generally 401k assets are protected in case of lawsuit or bankruptcy.

  8. I’ll echo what Beagle said. Walking away from the match is a mistake. Many companies match the first X%, often, it’s 5. Quick math – in the 25% bracket, it costs you $750 to put your $1000 in. Matched, it’s $2000. A year later, you are out of work and can’t pay the minimum bills, But you are in the 15% bracket. From the $2000, you net $1500 after adding the 10% penalty. Still in the 25% bracket and withdraw? $2000 nets you $1300.

    Disclosure – I am 50 and the Mrs is older still. Our 401(k) accounts are significant, and the statement we get each year shows the balance due to the matching. It’s 1/3 of our total.

    I understand the objection if one is carrying high interest debt. But, keep an open mind. Double the numbers above. $1500 out of pocket to deposit and match $2000 in the 401(k). That $4000 permits you to borrow (? I know) $2000 to pay the 18% credit card.
    Now, I do not suggest borrowing from one’s retirement account to pay off debt. But, when you show me the $2000 18% balance, and say you’ll skip the matched deposits, this out-of-the-box-thinking will kill the high rate, and when you pay off the $2000 balance in the 401(k) you find $4000 in the retirement account instead of just a paid off card.

    In the above scenario, you lose your job. The $2000 is deemed a distribution, and from the remaining $2000 you owe tax and penalty. You still walk away with money in the account, it’s not zero.

    The punchline for me, Never, Never, walk away from free money.

    1. I get what you’re saying – if this were a math equation. To me, though, money isn’t about math (and I was a math major!) Money is about MOTIVATION. And if the math side of it motivates you, great, then contribute up to the match. Unfortunately, I see a LOT of people who are doing it not because it motivates them to have that savings balance grow, but because some numbers person said they should. And then they’re not seeing progress on their debt because there’s a chunk of their income tied up; they get frustrated because they’re not getting out of debt; they have money in savings they can’t touch; and they give up. I hear it dozens of times in every You Vs. Debt session we run.

      That’s not everyone. I get that. But it’s MANY more people than I would have ever expected, and it’s made me feel pretty strongly about the motivation aspect. More than the match I guess I’d say the decision-making factor should be – “Are you making significant progress against your debts, AT A LEVEL THAT MOTIVATES YOU TO CONTINUE, with the contributions you’re making? (Match or not.)” And if the answer is yes, then keep contributing that if you want. But if it’s no, then I wouldn’t let a match stand in the way of kicking my debt to the curb!

      1. Psychological makeup is a power that Math can’t trump, I’m sorry to say. I agree, if my math and end goal doesn’t provide the same or better motivation, it fails.
        Keep up the great work, Joan!

        1. Thanks, Joe! I think that’s so hard for so many of us to get to … I know that for many years, and many (failed) debt payoff attempts, I was “doing the math” right and just floundering.

          Motivation has made SUCH a difference – it’s changed the equation, if you will!!

  9. I am still in 100K of debt (house, car, furniture, home improvement, MBA) (average rate is around 4%), so I am contributing to my 401K to get my company match (double the amount I put in up to 3%, i.e. I contibute 3%, they contribute 6%) as well while trying to pay down my debt. Provided the debt is way cheaper in terms of interest rate, I feel OK with my approach, even though it makes the debt pay-off slower… Right now I have about 24K in my 401K (age 30). I contribute to my 401k mainly because no other investment gives me an immediate and guaranteed 200% return, if I did not have the company match, I would have to agree with you – a bird in hand is worth 10 in the bush and I would not be contributing to 401K but will be paying down my debt as soon as possible, even though interest is lower than what I could earn in the 401K (it might be lower, but it is guaranteed return, no market up and down swings can take it away).

    I used to bend over backwards to pay stuff down, but at this point realize that I need to also live a little, so I am trying to find that balance between scrimping by and paying down debt fast and enjoying the pleasures of life (I still have not found it!). I would be much happier with debt being paid off, but it is going to take years and I have realized that focusing too much on it just takes the joy out of my life and adds unnecessary stress. I can’t have it all disappear right about now, so taking it slow and learning patience is the way to go for me. 🙂

    1. Kira, I think you’re very much keying into a LONG TERM approach. Much like weight-loss plans, debt doesn’t have a “magic eraser” that takes it away overnight, and if you can’t find something you can make work over the long run, not just while you’re paying off debt, but in the future to help you want to STAY debt-free, then short-term “starvation diets” (financially or otherwise) aren’t going to give you long-term results!

      I’m hoping you find that balance – we feel pretty good about ours, which we characterize as “mostly bending over backwards with occasional planned splurges,” like our DC vacation last year with our daughter – and it has definitely helped us stay the course!

      1. Looking at where this country is headed as a whole, I don’t know if I would worry about student loans, as I think that the value of a college education has become so diluted. At this stage of the game, ANYBODY can get into a college if you can write a check or ink your signature on a loan. And in reality, most people don’t end up doing what they went to school for anyway – with the exception of drinking a lot of beer.

        And getting into a “better” or the “best” school is a scam that the educational system plays so they can raise their tuition every year and people will bend over backwards (and get themselves into debt) so that they don’t have to feel guilty for giving their child “the best” (and don’t even get me started on helicopter parents!). I think that a more valuable education for a young adult (that is NOT provided in school) is how to manage your finances and financial responsibility. It would not be in the best interest of the schools to teach this … their profits would decline.

        My recommendation for kids today is either learn a trade OR take whatever classes you need to understand business at a community college, then figure out how to parlay that into an income (budding entrepreneurs).

        1. Catherine, we actually don’t expect that our daughter will go to college (her career goals at this point don’t line up with things that you would generally go to college for). We’re not big fans of the higher education system in America today, and as unschoolers, we have kind of been espousing the value of self-directed learning or practical-application learning!

  10. I think Joan is correct to understand the psychology of her own debt situation. 401k’s, IRA’s and the like are a very future looking investment, and they don’t do much for the here and now, other than help you feel more secure for the retirement future. (note: “secure” is a bad word choice b/c even savings could be devalued). Debt, savings, budgeting is more a mental exercise than a numbers game. Pay off what makes you feel the best, save how it makes you feel the best. Why? Because that will motivate you to do more of the same.

    I just broke the $100,000 barrier in my 401k, and it felt great!!! For me, that seemed to take forever, but after reaching that goal I am now more motivated to reach the next goal in the 401k account. I have an automatic contribution increase that hits in April. I wish it was today!! That is the kind excitement I want around all of my finances. That is how you get on a roll and make great things happen! (I also have an angry goal at one particular debt, that will be my focus this year.)

    1. Matt, I think you nailed it – you have to find what motivates YOU – and set the goals to match! Good for you on hitting that $100K mark, that’s amazing!!

      That excitement is what I want everyone to have!!

  11. I have always disagreed with Dave Ramsey on this. I think age is a big factor in this decision. My husband and I are 50 and have managed our finances very badly. We have significant debt that as accumulated over 20+ years and now we have borrowed to put 3 kids through college. It is going to take us 10-15 years to dig out of this hole. We have decided to continue to contribute to the 401K up to the matching amount while paying off the debt. The post-tax amount we would get from not doing that is not going to move up our debt freedom that significantly (maybe a year or two at best). And then we would be at retirement age with no savings. We feel this is far to risky. We are also able to borrow against this money at a very low interest rate, which is paid back to ourselves. Although this carries some risk if we lose a job, it has been a useful tool in getting our interest rates down. On the other hand If you are 30 and can pay your debt off in 5 years, than this might be a good plan as you have plenty of time to catch up.

    1. Linda, you make a good point about age. I’m coming at this as someone who is 30; my husband is 42. I VERY MUCH agree that the thinking on that could change if our ages were different. (We’re already in a different place with our thinking about my husband’s work than we are about mine, because he knows he is considered “mid-career” or worse in our field.)

      I also think you’re very right about the “how long will it take to dig out” piece. As I said in another comment, we’re talking about what I consider a short window – 4 years to being debt-free except the mortgage (ending in 2014), then hopefully less than 10 years after that, mortgage-free (probably closer to 8 years after that). For us, that makes sense. For a lot of people a little later in life, that would absolutely NOT make sense.

      Thanks for bringing up that key consideration! I really should have mentioned our ages in the main post, too – that is definitely relevant.

  12. When I read your numbers, I took them this way:
    You have $44,000 waiting for your retirement, $44,000 in consumer debt at 6% (14-8), and about $15,000(59-44) in consumer debt at 14%. At $2500 a month to debt, in 6 months your outstanding debt is effectively 6%. If you had a company match, that free money makes it even better. That’s my two cents. (we have no consumer debt outside of our mortgage, so we’re doing pretty good for Americans…)

    1. Robin, that’s awesome about being debt-free except for the mortgage – YEAH!!

      I see where you’re going with your numbers – I mentioned in another comment that I probably shouldn’t have used the 14% average estimate, because the debt we’re hitting with the extra money is the $17,000 balance at 22.99%. So in that case, it does make it harder to see the return you’re talking about.

      That said, I get the idea mathematically on it, and you’re right – in theory, the numbers COULD work out (if there was a match). But that doesn’t keep us motivated, and that’s really where we’re heavily focused!!

  13. I was discussing this with a friend the other day. He has debt, no savings for emergencies, and no retirement savings. But his income is starting to increase so he’s focusing on his higher interest debts while contributing to savings. Once the debt is gone, he’ll consider retirement savings; but right now, an emergency fund is more important than money he can’t access!

    1. Dona, I’m glad your friend is focused on that! Emergency fund FIRST AND FOREMOST in my book!! That rocks.

      And if he’s got that, and a good plan, he’ll make progress. I’m glad he has your support!

  14. Hi,
    This is the first post of yours that I read, and I have to admit it made me feel better. Just the other week, I was freaking out that we don’t have a401K or 403 or whatever it is. We haven’t been making quite the planned effort to pay off debt, but we are doing so. I see now that we really need to make a plan, get the debt paid off and then start investing in something that works for us. My husband has never liked this plans, although I’m thankful he had one at his old job. When he was fired, we were able to use that money.

    What I get the most from your post and the comments is that people have to do what they believe is right and not worry about everyone else.

    We’re getting our taxes done next week, and then it’s time to make a plan to get the car and my stupid student loan paid off that I’ve had for years! Talk about a waste of money in that had I been smarter, I would have been paying more on the principle over the years and it probably would have been gone by now. I’m older and much wiser now.

    1. Lori, you have gotten it 100%. PERSONAL MOTIVATION is key. That might and probably does look different for everyone. But if you’re doing something just because someone else says it’s the right thing to do, but you’re not motivated by it, then it’s hard to succeed!

      I can’t wait to hear your plan – please check back in and keep us posted!

  15. Savings for me and this is even after reading Your Money or Your Life and then hearing about the bonds in the economy basically having issues I am really glad I did not do this for both myself and my daughter. For both of us we have money market accounts and she has a five year CD. These I feel are the best options right now for saving for both of our futures. I also have a very paltry 401.

    1. Rebecca, I’m glad you have something that works well for you! I’m a pretty big fan of CDs – in fact, one of our main strategies post-debt when we get a significant emergency buffer will be a “CD ladder” of shorter-term ones. Money market accounts don’t get nearly enough recognition either.

      Good for you for having a plan that works!

  16. Hi Joan,

    First of all, I love the site. You and the team are helping people improve their lives and opening a channel for discussion/debate and that is great. I blog at, which has a similar theme; however, like some the contributors on this post, I’m in my mid 50s so my point of view and experience is slightly different.

    For one, I believe that if your $44k wasn’t in a “401k jail,” you would have spent the money based on your past money patterns. It’s easy to let the monthly contribution slip through your fingers if it isn’t forced into “jail.” Also, you would have only been able to blow around $33k instead of the full $44k assuming a 25% tax bracket ($11k would have gone to pay taxes.)

    I hope you leave your retirement nest egg in “jail” and find other creative ways to knock out your remaining debt (I said remaining because you’ve already managed to torch a bunch without using your retirement money). I recently posted a topic titled “10 Self-imposed Taxes That You Can Eliminate Now!” There may be a couple new ideas that would be useful to you or your readers. I welcome debate, too!

    Regardless, there are lots of right ways to go about building a prosperous life. It’s obvious that you are on the road to get there. Cheers, Ree.

    1. Ree, you’re right – the age does make a big difference! And I would say that in general, whatever you’re doing with your money, you have to be sure there’s a plan – so in our case, we actually have a plan that MAY involve cashing out in the future, but it would be for a specific purpose (and it’s not set in stone that we would do that).

      Similarly, we contributed in the past when that was what we thought was the best thing to do with our money, but looking back, it wasn’t even at the time – but that’s FOR US, not for everyone!

      You’re very right that the big danger is saying, “OK, I’m not contributing so I can pay off more of my debt,” but then frittering the money away! That applies to things like saving money on bills, too – if you save $1200 a year by cutting your cell phone plan a bit, but just blow it, then I’m not sure it was valuable!

      Good luck to you too!

  17. 3 days ago myself and my girlfriend payed off the last if our remaining debt- €50,000 in 18 months. I’m just like you, not able to focus on a second financial goal (or any other 2 related goals) at the same time.

    We have no emergency fund, retirement fund, or any other type of fund. We are simply debt free as of this week so need to drive forward. Our next step is to set up an emergency fund and enjoy the freedom that having extra money every month brings- hobbies, breaks, etc.

    A 3 month emergency fund is probably our ext target and to buy a decent car with cash.

    Although I didn’t read every post, I did get some great advice from MvD. Also, I see Dave Ramsey mentioned in some of the posts. His Total Money Makeover book was the biggest motivator for us to stick to our decision to be debt free. Now that we are, we have huge possibilities for our money.

    Thanks guys.

    1. Steve, I’m a big TMM fan too! And I think you and I probably think very similarly – not only in the idea of needing one goal at a time, but also in the ideas of enjoying the freedom of extra money and also seeing that being debt-free is the BIGGEST door-opener in your financial life! 🙂

      Way to go to you guys on being debt-free!!! I am THRILLED!

  18. Kenneth Story

    I only contribute as much as my employer will match. If they weren’t matching anything then I’d be making less on my 401k than I’m losing on my interest rates, but when they match 100% up to 2% of my income, that means that I’m essentially getting a 100% increase on whatever I put in (up to the 2% limit). The total amount might not gain more than 8% a year, but I’m still doubling the money I personally put in.

    1. Kenneth, that makes sense – I think the important part is that you’ve figured out under what circumstances contributing benefits you, and you also see the points at which it wouldn’t! I wish more people would look at that!

  19. Joan,

    I am so glad you took an honest look at your 401k. For your average investor, it is a good idea.Most people forget about that nasty tax burden at the end. As that investor grows they soon realize they have pigeon holes there money with the 401k. An engaged investor has ways to do far better than a 401k, without the tax burden (life’s single largest expense).

    Please take this as a compliment, but since Ive been following your blog, I have seen your financial intelligence grow tremendously. You have moved passed the 101 knowledge and have moved on to 201 and some 301 knowledge. Stay this course and you will not only be financially independent, but will move on to financial significance.

    As far as school education goes, we took the easy route for our son. We bought an rental house. When he hits 18 he will be given a choice, rent the house, live in the house, sell it to start a business, or sell it to go to college. No other means will be allowed. The best part, we have mainly the upfront down payment cost for this house. Tenants will cover the rest (minus the risks).


  20. I am glad to see you weighing all the options, Joan. It makes me feel better about weighing mine and deciding what is best for me. You chose to stop contributing to your retirement plans for now, while I have not. I just paid off ALL of my graduate loans, but I still have just under 17k in student loans from undergrad at an interest of 3.5%. I pay approximately $700-800/month to my loan, depending on how much I make waitressing that month (my side job I took on to pay down debt faster). However, I haven’t stopped investing.

    I contribute $150/month to a Roth IRA and I have almost 17k in that account. Sure, I could withdraw it with a penalty and then pay off almost all of my debt, but that money is currently working for me and growing. If I took it out now I’d be starting at zero, and that is not something I’m willing to do for my retirement. I also started contributing to a TIAA-CREF retirement account via my employer. I contribute 5% of my paycheck ($90), tax-free, and they contribute 12% of my total salary. TWELVE PERCENT! I’d be a fool to not have that account.

    As much as I want that debt gone, the $240 a month I’m putting towards retirement isn’t enough to make me want to use that money to pay off my debt. If I found $240 was being used on cable or the gym, then yeah, I’d cancel that and use the money to pay down debt. But it is going to a place that will help me in the future so I am okay with that. I’m so focused on paying off my debt that I feel like I need to make sure I’m putting money other places that will make my overall financial picture more solid, which is also why I beefed up my emergency fund to $4k before I started attacking my debt seriously.

    Thanks for the blog post!

    1. Katie, that 12% sounds pretty amazing! I don’t know too many places even coming close to that nowadays!

      Good for you for having a system that works – it sounds like it’s doing exactly what it needs to be doing for you to be in a good place!

  21. I am only contributing $20 a month to my retirement, which brings it to the grand total of 1k. When I had a career job, there was no match and I was young and dumb so I didn’t take part. I am now left with 55k in student loan debt to payoff (originally 68k) and focusing on getting rid of as fast as I can. My goal is to be debt free within four years, by the time I am 32. Once I am debt free, I am going to take the 1-2k per month and divide it between retirement, emergencies and travel!!

    I really resonate with 3 and 4 in your post. I am going to be debt free forever! I don’t even have a credit card, I just got stuck in the student debt trap and thought it was the right move at the time.

    1. EXCELLENT on being debt-free forever!! That rocks!! And it sounds like you have a good plan in place to get where you want to be! 🙂

  22. Just wanted to give a slightly different perspective on “focus” – we, too, do better when we’re focusing on just one thing, but with a houseful of kids (well, two of them aren’t in the house anymore but their tuitions are still in the budget), the debt paydown gets interrupted pretty regularly. It’s in those moments, I’ve found in the past that I began to panic about the lack of retirement plans, etc. So our solution is that we have small contributions to our employer-match retirement plans, plus I have $10 each per month transferred to a couple of other accounts: savings for the eventual 3-month emergency fund on top of the current $1K, savings for the next car, etc. Because we are continuing to make (slow) progress on the debt paydown, it’s usually several months between panic attacks, which means that there will have been visible, automatic increase in those other areas, which helps me talk myself off the edge. I’d recommend that to anybody else who feels like too much focus doesn’t work with their particular anxieties 🙂

    1. Good point – it’s about what makes YOU feel successful (and not panicky!) In our house, the emergency fund is definitely like that – we HAVE to have the money in there or I get itchy.

      So glad to hear you’re making progress – and feeling good about how you’re doing it! That’s super-important!

  23. For me this is definitely a matter of mind over feelings. It doesn’t “feel” right not to contribute to my 401(k) but I trust that it is right. We have $50,000+ worth of debt, some of which has outrageous interest rates. That needs to come first. After 20 years of contributing to my retirement I have $400,000 in my account. With my pension I am not going to be destitute when I retire but … it still doesn’t feel right not to contribute. I’m just putting my head down and working on our debt.

    1. Ginny, I don’t know your age, but I feel like even if you never had another cent beyond that $400,000 – it would take you A LOT farther if you’re debt-free in conjunction with it, then if you’re looking at the same amount of money and debt that needs to be serviced, especially at outrageous interest rates!

      We look at our lives and have some calculations on how many “years” we’re buying, essentially. And if we’re debt-free, the same amount of money would buy us something like 6 times as many years as it would if we kept our current debt level. That’s sobering – but motivating!!

      All that said, if you get that debt down, the future is yours – you can contribute 3 times more to your 401(k) if you want!

  24. A very interesting perspective. I would agree with an above commenter who mentioned that the 401K protects us from ourselves. Since your company doesn’t have a match then your strategy makes more sense. I like how you focus on 1 thing at a time. This is the best strategy on tackling your pf finance I have seen.

    1. Kevin, I LOVE the focus concept. I admit, that’s probably the “best of the best” in terms of motivation for me.

      And I think you’re right – there is an aspect to which there are a lot of people who want someone to protect them from themselves in many areas. I’m not that person, but I respect it as a personality trait! I just feel like there are people for whom that’s not their personality, forcing themselves into that box, you know?

  25. This is a good article. I have been kicking this idea of taking funds out of my 401k to consolidate all our debt. Currently it is around $50k and I have more than enough in my 401k to cover it. But conventional wisdom and my parents always told me to never touch that money before retirement unless in dire need. I just am a little confused as whether this is considered dire need or not

    1. Alan, only you can decide that – would you be talking about a loan, or a withdrawal? I’m REALLY not a huge fan of consolidation loans (I’ve talked about those before, and links are in some of the other comments) – but in our case, there are situations under which we’d withdraw our balance and take the tax hit in the future (just depends on circumstances at the time that option would be available to us!)

      I think the biggest thing is, if you have a PLAN, something like this can work, but if you don’t, it generally doesn’t get you ahead in the long run.

      In other words, if you’re going to get any big sum of money and pay off or drastically pay down your debts… then what? Is there a plan to keep you from accruing new debt? Do you have an emergency savings fund? Do you have a month’s worth of expenses just in your main bank account as a buffer? Do you know how you plan to save for the future?

      If there’s a concrete answer to all of those, that changes whether it’s a good use of the money. If you’re not quite that solid on your plans yet, then the MENTAL situation has to change before the financial one can… if that makes sense?

      1. Hi Jane,

        It would be a loan out of my current 401k balance. I would not withdraw the money. If we could consolidate everything into only one payment, I think it would significantly reduce our monthly cash outflows to allow us to build an emergency fund as well as have enough in the bank to pay a month or two of bills should something happen. I need to do a little more consideration on it, but if it worked out as planned, it may also allow us to pay it down faster than planned. I guess it would come down to the interest rate TIAA-CREF would charge and base it on what I currently am paying. As far as not getting into debt again, we basically will stop making stupid decisions. We made three poor decisions that got us to where we currently are. But since have hammered out about $15k in debt over the past two years. Still have about $50k more to go.

    2. Alan – a hardship withdrawal has specific rules to be permitted. You should ask your benefit department to tell you the exact documents you’d need to provide. You should also be aware that a hardship withdrawal often means you will not be permitted to deposit for some time. Lost deposits as well as the match they’d have gotten you.

      I’d try to talk you out of a withdrawal. I’m with Joan, advising to avoid the loan. Yet, if you insisted on withdrawing the $77K (assuming 25% tax and 10% penalty) to net $50K, well, borrowing $50K feels less destructive to me. My first choice is to simply pay the debt with a vengeance, a 3-4 year payoff if you can.

      1. Actually, I would be looking into a loan. The best part about my company is that they offer TIAA-CREF and Vanguard for retirment choices. Only TIAA-CREF offers the loan so I would have to transfer enough over to them since they only let you take a fraction of the total amount. If I did that, I would not be able to deposit into TIAA-CREF but could still contribute into Vanguard. My company matches 10% of my salary regardless of what I put in there. So I would not have to worry about lost deposits or matching contributions. My main concern is the terms and interest on the loan. Would it be beneficial to consolidate all my debt into only one payment. Would it save me monthly that I could build up an emergency fund as Jane has stated. At some point I will probably call them to at least weigh my options.

  26. In a lot of ways, I completely agree with you Joan. It doesn’t make much sense to be saving money away when it could just as easily be going towards higher interest debt and creating increased cash flow for future investments.
    I do have to disagree a little on the company match part. The company match is an automatic gain. If the company matches 50% of the first x% you put in, that’s an instant 50% gain on your money. Unless you’re frequenting a lot of payday lenders, you likely don’t have any debt that will be charging you that sort of rate. Now, granted, it’s only a 50% gain that first year, and then it’s back to whatever rate the investment makes, but the power of compound interest kicks in there too. (besides the fact that you can’t take it out without penalty.) Even without investing much anywhere else, I try to take advantage of the company match as much as I can.

    1. Shane, I think that depends.

      A lot of the issue I have with match is with vesting (which I haven’t really delved into in other comments, but for some reason the numbers in your comment really drove it home to me.)

      While I’m hearing a few stores in the comments of really good matches, most places in our area don’t have matches that are very high, and most of them are tied not only to a percentage of your contribution, but a percentage of your salary.

      So, here’s a large company I know of. It matches up to 1/3 of your contribution but not to exceed 3% of your annual gross. I have a friend in that situation whose gross is $35,000 – so her match at BEST is $1,050 a year. And to get that, she has to contribute about $60 a week or $120 a check – pretty hard when your check is $900 after taxes and BEFORE health-insurance deductions in the range of $275 per family.

      That said, there are more prosperous areas of the country (and world), to be sure. And there are certainly more prosperous income-earners, so their max would be higher.

      But it’s not in my experience a straight match by far for most people, or even a straight 50% match on your contributions. Even the places where it is, it’s not “yours” until 3, 5, 7 years later thanks to vesting. (We’ve got a couple big employers who have an EIGHT-year vesting. For real? I don’t get all that money unless I tie myself to you for 8 more years? No, thanks. I’ll pay the “penalty” for flexibility!)

  27. Joan,

    You’re absolutely right about our own finances being personal. Specifically, we all need to ask ourselves what will ultimately let us sleep at night.

    Most people assume that money is just about hard numbers – that it is black and white. But it is also very much about emotions and psychology.

    Being in debt is a huge psychological burden for some people. For them, it just makes sense to get rid of that feeling of being trapped ASAP, even if the overall return on investment isn’t great.

    It’s OK to focus on just one thing at a time. For example, some of my friends keep a dozen bank accounts just because some give them a higher interest rate or others charge them less fees. Personally, I would go crazy tracking all that. I just want a few simple accounts. They can keep that extra 0.5% interest bonus.

    Bottom line: do what works for you, and not what everyone else is doing. After all, it’s your money.

    1. Ivan, that’s a great point about the accounts too. I am also not a fan of dozens of them. I have one very close friend who, with her husband, has something like 6 or 7. That’s not feasible for me!

  28. Joan,

    You should include the tax implications of contributing to a 401(k) or other tax-deferred retirement plan in your discussion – especially since your recent post was about hustling to cover an IRS tax liability.

    You “earn” the spread between your current marginal tax rate and your rate at withdrawal on top of whatever return you realize.

    For argument’s sake, your cost to carry 5k of debt at your highest interest rate of 23% is about 1150/year (ignoring compounding for simplicity). Assuming you take that 5k and put it into a 401(k) you might reduce your tax liability by 1250 that year and earn your 8% on top of that. Of course, you’ll pay tax on that income when you withdraw it during retirement but it very likely will be at a lower marginal rate than you are paying now.

    If you were able to reduce the cost to carry your debt (i.e. paying off that 23% debt so you’re “only” paying 14%) the payoff is better. And better still if there’s a match.

    Keep up the good work.


    1. Craig, that’s a good mathematical point – in our case, it wouldn’t have changed our liability very much, even at the max contribution we could make (due to how we file and what it was from), so I didn’t factor it in, but it IS worth discussing if you’re making these decisions, for sure!

  29. Saving is always a good idea even when you are in debt. The percentage of your income that you save should reflect your personal goals, so if your main financial priority is to pay off debt then the majority of your income should be allocated there. However investing even a small percentage of your income makes sure that you maintain good financial habits and learn to budget. Great post, I am going to share it on our Dinks Finance roundup next Friday. Happy Easter.

  30. My employer is discontinuing our 401k – economy is destroying our company – therefore, I am getting my money from the 401k and do not intend to invest it all – i wanted to take the money (knowing i will take approximately a 30% tax hit and early withdraw penalty) pay off all of my debt and with whatever is left put it into an IRA – my husband is ill and we have become more and more in debt due to his illness. It would be so less stressful for me to be out of debt take the tax hit and start fresh and be able to deal with his illness than do anything else. Is this a wrong decision. I am going to see my accountant about this but just wanted a few bits of feedback so I dont go in this meeting not having a plan

  31. I disagree that these investment vehicles are bad ideas. With today’s savings rate, these are a much better option than a savings account and they may even be tax-free when used what it’s for.

    The 529 and/or 401k would be the last place I would withdraw since you’ll be hit with a 40% penalty.

    Perhaps if you had an 6 month emergency fund, you could have used that instead?

  32. Pingback: What is Financial Independence - Beating Broke

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