Contributing to your 401k when you are in debt

Written by
Peter Dunn

"Hey, Pete!" shouts a workshop attendee from across the room. I look up. A lady in her 40s walks over to me with excitement in her step. "Pete, I'm so excited to take control of my financial life. Thanks for getting me excited," she added.

"It's my pleasure, I just feel bad that you had to listen to me for an hour," I say. Like most people, I don't handle compliments well.

"There is one thing that I'm confused about. I have $20,000 in credit card debt, and haven't started saving for retirement. Should I be contributing to my 401(k), or should I be focusing on debt?" she says with a nervous look.

Knowing what's next, I answer, "both."


And here we go.

Being in debt is not a death sentence. In fact, pulling yourself out of debt can be one of the most freeing experiences that you can experience. One of the side effects of being in debt is that you generally lose track of time. And you lose track in several different ways. First of all, you run in place for a 6-12 months until you figure out that debt sucks. You realize that more and more of your income is going to pay for stuff that you bought a long time ago. Then you lose time perspective on the future. You get so consumed with debt, that you forget that there is a future after debt. This is common.

The most forgotten financial tool available to you is time. Debt reverses the power of time. It forces you to pay for your past. Not only that, but you are paying interest on your debt, which makes the problem worse. One of the best uses of time is your contributions to your 401(k). There's an old saying, "the early money is the best money." Oddly enough, I just Googled "the early money is the best money," and apparently it's not an old saying. Hell, I've been saying it for years. Apparently I made up this saying. So, like I was saying, "the early money is the best money." This means (according to the phrase's creator, Peter Dunn) that the money you contribute now is more important than the money you contribute 1 year from now. This is because it will have more time to grow, thus it is the most powerful contribution. Just as last year's contributions are more powerful than this year's contributions. Therefore you really shouldn't pass up the opportunity to contribute early money, especially when you have have made poor decisions in the past that have already wasted so much time.

There are several considerations to consider. That's right, I just typed the stupidest phrase ever, "consideration to consider." But frankly I'm too proud of a person to hit backspace. I promise not to bring it up again if you don't. Moving on. These questions will help you better understand what to do.

1. Do you actually have a debt reduction plan? This is so vitally important. If you don't have a plan, then chances are you are going to be wallowing around in debt for a while. What I am going to say next is not only counter-intuitive, but it's also a bit dangerous. If you have no plan to get out of debt, then you need to be contributing to your 401(k) immediately. The fact of the matter is, only you can decide when you are ready to pay off your debts. I've met with people, given them a brilliant debt pay-down plan, and they've neglected it for years. I'm realistic. If you are going to muck around in debt for a while and not care, then you might as well save for your future immediately. Besides, you clearly aren't listening to me tell you why to get out of debt, so you probably want to get as much of your income out of your hands and into your 401(k) as possible. You clearly have no business making decisions about your financial future if you are refusing to create a debt reduction plan. Max-out your 401(k) contributions, and when you finally get a plan together then proceed to question #2 (conveniently located below).

2. Does your employer match your contributions? Ah yes, the matching conversation. The patron saint of high school economics, Cal Ewing, told us on the first day of class that there is no such thing as a free lunch. It turns out he was right. Although, the closest thing I have found to a free lunch is your employer's matching 401(k) contribution. Many employers via benevolence, guilt, or stupidity will make deposits into your retirement plan, as long as you do. This contribution is called the match. You need to know exactly how your match program works. The question you need to find the answer to is, "how much do I need to contribute to my retirement plan in order MAXIMIZE the employer match?" This is an important tip for anyone, but especially for those in the midst of paying off debt. The debt-free person clearly shouldn't just stop at the match. They should contribute significantly more to their retirement plan. However when you are in debt, you should only contribute up to the match. This means you must contribute to your retirement plan as much as it takes to MAXIMIZE your employer's match. This is a very wise move. You need to make sure your future is considered, despite the fact that you are paying for your past.

Do not waste the power of time. Sign up for your 401(k) yesterday.

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