3 Great Reasons to Forego 401(k) Contributions This Year

You've probably been told you should contribute to a 401(k) every year if you have one and can afford to do so. That's normally good advice, but there are a few exceptions to the rule. If any of the three things below apply to you, you might be better off avoiding your 401(k) this year.

1. You're focusing on paying off your high-interest debt

High-interest credit card or payday loan debt can easily cost you more in a year than you'll earn by investing your money in a 401(k). So if you have this type of debt, it's usually a good idea to prioritize its repayment over retirement savings.

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There are several ways you can go about this. The easiest is the debt avalanche method. To do this, you note your balance on every credit card you own and their interest rates. Then, you make the minimum payment on every card each month and put all your extra money toward the card with the highest interest rate until it's paid off. Then, you move all your extra cash to the card with the next-highest interest rate, and so on, until all your cards are paid off.

You could also use a balance transfer card or a personal loan. Balance transfer cards temporarily halt the growth of your balance, but there's often a fee for doing this, and you'll need to transfer the balance to a different card issuer. Personal loans give you a predictable monthly payment, but since these loans don't have collateral, the interest rates can be a little higher than what you'll find on some other types of loans.

Once you're out from under this high-interest debt, you can begin putting all that extra cash every month into your 401(k) or another retirement account that appeals to you.

2. You're contributing to another retirement account instead

401(k)s offer numerous advantages, like high annual contribution limits and the possibility of a matching contribution from your employer. But they have their drawbacks as well.

You usually only have a few investment options with a 401(k), and they may not be very affordable or well suited to your investment goals. If you don't like your investment options, you can ask your employer to offer some different ones, but it doesn't have to comply.

A 401(k) also doesn't allow for large, one-time contributions or prior-year contributions like IRAs do. This might not be a problem for everyone, but if you think you'd like to make one-time retirement contributions, you'll need to use an account other than a 401(k).

Most people turn to IRAs if they don't like their 401(k)s. These offer more investment options, which gives you more control over what you're paying in fees. But contribution limits are lower. You may only contribute up to $6,000 to an IRA in 2022 ($7,000 if 50-plus) compared to $20,500 for a 401(k) ($27,000 if 50-plus). So an IRA may not be enough on its own.

You could either contribute to your IRA until you max it out and then fall back on your 401(k). Or you could look into other retirement accounts, like a self-employed retirement account if you have your own business or a side hustle. A health savings account (HSA) also makes a great retirement account.

3. You prefer to pay taxes on your retirement savings up front

Most 401(k)s are tax-deferred, which means your contributions reduce your taxable income for this year. But then you pay taxes on your withdrawals later on. This is ideal for those who believe they're in a higher tax bracket now than they'll be in once they retire. But if you think you'll be in the same or a lower tax bracket, a Roth retirement account might suit you better.

Contributions to Roth retirement accounts don't reduce your taxable income for the year, but then your money grows tax-free. You won't owe a thing to the government once you take your money out as long as you wait until you're at least 59 1/2 and have had the account for at least five years.

Some employers are now offering Roth 401(k)s to their employees who want the high contribution limits of 401(k)s and the tax advantages of a Roth IRA. This is a smart choice if it's available to you. But if it's not, you may have to contribute to a Roth IRA first and then switch back to your 401(k) after you've maxed out your IRA.

None of this is meant to discourage you from contributing to your 401(k) if you feel it's the right home for your money. But you shouldn't just throw money in it just because it's there. Make sure you understand the pros and cons of all the retirement savings accounts available to you and choose the one(s) that make the most sense for you right now.

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