6 Valid Reasons Not to Contribute to Your 401(k)


You’ve heard that you should contribute to your company’s 401(k), almost always. Don't feel bad or question your financial judgment if you've decided to invest elsewhere. There are valid reasons to be an exception to this general rule. (See also: Is It Time to Starve Your 401(k)?)

1. Your Company Doesn’t Match Your Contributions

If your company doesn't match your contributions, then 401(k) participation is not especially attractive. When I worked for large corporations, I contributed to my retirement through 401(k) plans but never received an employer match. Although I enjoyed the automatic savings feature and reduced tax liability, I didn't get bonus money from my employers for saving.

Many advisors emphasize that you should set aside enough money to get the employer match. However, they often don’t mention that nearly half of employers don't provide this incentive.

Not getting a match shouldn't automatically dissuade you from contributing to your 401(k) plan at work. But this scenario should encourage you to consider other retirement account options.

2. You Plan to Leave the Company After a Couple of Years

Even if you are eligible for the company match, you may not receive this money when you quit your job. Generally, you need to work for your employer for a while to become fully vested and receive the matching dollars. A notable exception is the Safe Harbor 401(k) plan, which requires all employer contributions to be fully available to employees regardless of tenure.

Vesting schedules vary. Typically, you’ll need to be an employee or participate in the plan for several years. Often, you’ll get ownership of the match over time or at the end of a specified term (for example, you'll gain access to 20% every year for five years or get nothing for the first six years and then become 100% vested in year seven). Look at your 401(k) plan documents to determine when ownership of the employer match is transferred to you. Note that you always have ownership of your contributions.

Just as not getting a match doesn't negate the value of the 401(k), having to wait to become fully vested doesn't mean that you should definitely skip enrollment. However, it's helpful to consider your career plans and vesting schedules when making this decision.

3. You Want to Pay Off High Interest Debt

If you are carrying thousands of dollars in high interest debt, then you may want to focus on paying off loan balances at home instead of contributing to your 401(k) plan at work. Diverting money from retirement funding to debt payoff for a couple of years could make sense, especially if you are burdened financially and psychologically by credit card debt.

Company matching percentages, loan interest rates, loan balances, tax brackets, and investment returns play a role in calculating what is best for your situation. For a discussion of this topic, see Philip’s post on funding your 401(k) when you’re in debt.

Your goal should be to establish a habit of financial discipline, whether contributing to your 401(k) plan or paying off loans. Consider your financial priorities and inclinations; if you opt to pay off credit card balances, commit to spending less than you earn and building your retirement account as soon as your high-interest balance hits zero.

4. Your Employer Offers a Lousy 401(K) Plan

You may choose to invest on your own rather than put money in your employer's 401(k) if the plan has undesirable investment options and unreasonably high costs.

Look at the disclosures to gain insight into the worthiness of your company's 401(k) plan. According to the Society for Human Resource Management (SHRM), you should receive information on mutual fund performance compared to benchmarks as well as administrative, investment, and service expenses. See this infographic for an explanation of the differences in these types of fees. In addition, check BrightScope ratings to see how your employer’s plan compares with its peers.

Certified financial planner Roger Wohlner gives tips on the types of mutual funds that may indicate a lousy plan. For example, if your choices are limited to proprietary funds associated with the plan provider, one fund family (only T. Rowe Price funds in all asset classes, for example), or expensive share classes, then your plan may not be designed for the optimal benefit of employees.

Examine your 401(k) to figure out if your employer is offering an excellent, average, or subpar plan. Based on your discovery, you may decide to open and fund an IRA to build wealth instead of participating in your company's plan.

5. You Need Cash to Make a Down Payment on a House

While you can tap your retirement funds by taking a hardship distribution or borrowing on your balance, there is a simpler way to get money for the purchase of a primary (or principal) residence. Forgo 401(k) plan contributions for the moment, save in a regular account, and earmark funds for this purpose.

If you withdraw money from a traditional 401(k) account prior to retirement age, you will owe taxes on the distribution amount plus a 10% penalty in most cases. Also, you won’t be able to contribute to the plan for several months. Alternatively, you could borrow from the account; however, a loan detracts from your long term ability to save plus requires you to pay outstanding balances immediately if you leave your employer.

So, rather than funding your plan at work, consider setting aside a certain amount to accumulate a down payment. Then, after you purchase the house, you can start (or restart) contributing to your 401(k).

6. You Want to Fund a Roth IRA

If you have a healthy balance in traditional retirement accounts (and your employer doesn't offer the Roth designated account within its 401(k) plan), you may want to skip contributions at work and put money into a Roth IRA.

While traditional retirement plans give you a tax break now, the Roth allows you to withdraw funds tax-free when you reach 59½ (or earlier in certain circumstances). Also, unlike regular IRAs and traditional 401(k)s, you can take money out of the Roth at your leisure rather than according to a certain schedule in retirement.

To be clear, you don’t have to choose between a Roth IRA and your employer’s 401(k) plan (however, there are income-based limits on Roth contributions). But if you meet income standards and have limited amounts of money to save for retirement, then you may want to stop participating in the 401(k) plan in order to fund the Roth IRA.

Certainly, there are many reasons you should participate in a 401(k) plan, including the ease of setting aside money for your retirement on a regular and automatic basis plus the ability to save a large amount each year within this retirement account (more than $17,000 per year in a 401(k) plan versus just $5,500 in an IRA). But you shouldn't feel uneasy if you decide to take a different route, particularly for a year or two, depending on your circumstances.

Have you decided not to participate in your company's 401(k) plan? Have you still been able to save for retirement?

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Guest's picture

Roth IRAs are most likely going to be the best bargain when you're very young and just starting out, especially if you have kids and a mortgage. (Once you tap out any matching contributions on your 401-k, of course.) Lower wages and higher deductions mean that your tax bracket is likely to be very low compared to later in your life. If you are among the 47% of Americans who pay no income taxes, it's pretty much a no-brainer!

But if you're in a higher tax bracket and are getting close to retirement, a Roth IRA is far less appealing.

Guest's picture

These are some pretty good reasons to not contribute to a 401(k). I wish more people knew about these, too many people blindly contribute without considering the big financial picture. And, like you mentioned, not all 401(k)s are created equal.