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Financial Planning - Financial planning in general. (Moderated)
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Posted by Elle on June 10, 2008, 2:42 pm
Regarding prioritizing 401(k) contributions up to the match
over an emergency fund:
>> If the guy loses his job, how
>> is he going to keep paying the mortgage?
>
> How long does it take to process a separation-from-service
> withdrawal
> from a 401K? If he loses his job, he could cash out the
> part of the 401K
> that was funded at the expense of his emergency fund
> (including the amount
> arising from tax deferal). The matching funds would more
> than cover the
> 10% penalty, leaving him with more of an remaining
> emergency fund than he
> would have had he directly funded the emergency fund
> rather than the 401K.
> Am I missing something? While not completely eliminating
> an emergency
> fund, it seems like you could make do with a smaller one.
In my opinion, the importance of keeping money in tax
advantaged retirement savings cannot be overstated. That
money is for retirement--a whole other category of savings--
period. When withdrawing as you propose, you lose the tax
advantage on the withdrawn amount forever; you may have to
withdraw when the market is down, causing loss of historical
returns; you lose 10% for the penalty (with some
exceptions); and you lose the taxes you must pay on the
distribution.
When one starts calling one's 401(k) (or IRA) one's
emergency fund, then one is simply not saving enough, in my
opinion, and is rationalizing bad financial behavior. If one
insists on thinking of a part of one's 401(k) as one's
emergency fund, then better invest that part in something
mighty conservative. Meaning you lose returns.
I advise having a separate emergency fund.
Two cents.
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Posted by Will Trice on June 10, 2008, 7:35 pm
Elle wrote:
>
>
> Regarding prioritizing 401(k) contributions up to the match
> over an emergency fund:
>
>>>If the guy loses his job, how
>>>is he going to keep paying the mortgage?
>>
>>How long does it take to process a separation-from-service
>>withdrawal
>>from a 401K? If he loses his job, he could cash out the
>>part of the 401K
>>that was funded at the expense of his emergency fund
>>(including the amount
>>arising from tax deferal).
> When one starts calling one's 401(k) (or IRA) one's
> emergency fund, then one is simply not saving enough, in my
> opinion, and is rationalizing bad financial behavior. If one
> insists on thinking of a part of one's 401(k) as one's
> emergency fund, then better invest that part in something
> mighty conservative. Meaning you lose returns.
While I agree with you about the OP possibly not saving enough, I think
you missed Xho's point (and maybe Joe's, too?) that when prioritizing,
maybe the 401(k) should come before the emergency fund, at least up to
the match. Of course, that doesn't address other emergencies that don't
result in a separation of service...
-Will
william dot trice at ngc dot com
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Posted by Elle on June 10, 2008, 8:40 pm
> While I agree with you about the OP possibly not saving
> enough, I think > you missed Xho's point (and maybe Joe's,
> too?) that when prioritizing, maybe the 401(k) should come
> before the emergency fund, at least up to
> the match.
I suppose if the match is high enough; vesting is not a
problem; one recognizes that one may have to put more into
the 401(k) to realize (upon emergency withdrawal) the same
s/he would realize if the money were not in the 401(k) (blah
blah pre-tax and after tax effects); has the discipline to
invest (the emergency amount) in a money market fund or
short term bond fund within the 401(k) (is that usual?); and
one can stand the administrative delays that seem often to
go with getting money out of one's 401(k) pre-retirement,
then I can tolerate Joe's, Xho's, and your argument. That's
the extent of it for me. Too often a car breaks down;
someone's AR mortgage adjusts up; someone loses a job; a
parent has to go into a nursing home and $7000 is needed now
as a deposit until say, Medicaid kicks in; a lawyer needs to
be paid while you divorce your spouse etc. for me to put
serious faith in this argument. It is a lovely academic
exercise, though. :-)
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Posted by joetaxpayer on June 10, 2008, 9:35 pm
Elle wrote:
> It is a lovely academic
> exercise, though. :-)
You are right about that. There's always some missing details about a
given situation that means unknown variables. Not to mention one's
'feelings' about borrowing or risk level.
Strictly choosing between the emergency account and the (matched)
401(k), I view it this way: Assuming 25% bracket (that's fair, no?), one
can put $1500 in the emergency fund vs putting in the gross $2000 and
having it matched up to $4000. Fired at the end of the year? $3000 after
tax minus $400 penalty, leaves $2600. Yes, I propose the 401(k) loan
substitute as the emergency fund, as you're able to borrow out half at a
decent rate. I understand I am on thin ice with you when I go this way.
I understand that. I just can't advise ignoring that match.
Joe
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Posted by Elle on June 11, 2008, 7:05 am
> Strictly choosing between the emergency account and the
> (matched) 401(k), I view it this way: Assuming 25% bracket
> (that's fair, no?), one can put $1500 in the emergency
> fund vs putting in the gross $2000 and having it matched
> up to $4000. Fired at the end of the year? $3000 after tax
> minus $400 penalty, leaves $2600.
The only amendment I would offer is that it seems the most
frequent rate of 401(k) matching is 50%. So "... matched to
$3000. Emergency arises? $2250 after tax minus $300 penalty,
leaves $1950." Though again, a person has to be braced for
not being able to get the 401(k) loan/distribution
immediately.
I dislike the inaccessibility. "Emergency" to me means one
needs the money /now/. Yes, one can use a credit card to
bridge some of the immediacy problem, but I do not like
this. For someone under the gun, adding more for them to
track is not helpful, and the credit card interest could
steal away the remaining gain from the match.
> Yes, I propose the 401(k) loan substitute as the emergency
> fund, as you're able to borrow out half at a decent rate.
> I understand I am on thin ice with you when I go this way.
No thin ice. For someone who is careful (e.g. checks the
details of his/her 401(k), including matching amounts,
vesting requirements, loans, and time required to get a
distribution, plus is willing to juggle, say, credit card
debt as a bridge), doing as Xho, Will, and you propose can
make sense. A number of articles on the net suggest doing as
you say. Other articles prioritize the emergency fund
outside the 401(k). I think putting the emergency fund first
is more helpful to the typical person who really has not
much savings and is struggling to get a grip on his/her
financial situation and job. That is, s/he is in precarious
straits to start with, so confusing him/her with what I
think is some pretty heavy minutiae on 401(k) plans is not
helpful. Does s/he really have time to find out how quickly
s/he can get a hold of her 401(k) money and document this
somewhere so s/he can get right on it should that emergency
arise? We do get some nasty reports on 401(k) delays, after
all.
A truth halfway between your and my general guidance is
perhaps worth contemplating: Something like fund both the
401(k) to the match while also having a 12-month plan to
fill the emergency fund. This actually seems pretty common,
from reports on the net. Orman and Ramsey often seem to lean
this way. Burns, not so much.
Or, with all due respect, we are kind of splitting hairs. A
lot of people happen to keep a buffer of cash of several
thousand dollars, ISTM, just lying around.
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Misc.invest.financial-plan is a moderated newsgroup where Moderators strive
to keep the conversations on-topic for financial planning. Other posting
guidelines include a request for brevity and another for trimming posts to
which we respond. For all of the other tips and suggestions, see "FROM THE
MODERATORS: Posting to misc.invest.financial-plan", a weekly post now on the
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