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  • Writer's pictureBridget Sullivan Mermel CFP(R) CPA

Don't Max Out Your 401K

If you were to get on the Internet and poll the financial

gurus, the message you would get load and clear is: Save

Money. No matter how much you've saved, you will be woefully

short when you get to retirement.

The first suggestion of these pundits? Put money in your

401(k). (I will use "401(k) as a surrogate for all retirement

savings plans: 401(k), 403(b), SEP, SIMPLE etc.)

I'm not against 401(k)s. Actually, I'm a big fan. However, I

think the advice is wrong.

Here's my message: Save 10% of your income.Put your money in

a savings account. This will become your emergency fund.

Accumulate 10% of your annual income in your emergency fund if

you've got a regular job. 20% if you worry you're on the

brink of losing your job or are self-employed.

For the first 6 months or so, this amount might seem measly

and the whole project might seem like it's not worth it. You

can supplement your saving by putting in money from any cash

gifts, tax refunds, or other windfalls. Don't put 100% of the

unexpected money in your saving. Put 33% to your savings, 33%

toward your credit cards or other debt, and 33% go out and

spend. If you don't have any debt, the proportion is 50/50.

Once you're got a fully funded emergency fund, start saving in

your 401(k). But even then, don't max out your 401(k). Find

out what your company match is. (Your company match is how

much your company puts into your 401(k) for every dollar you

do.) Instead of putting the 10% of your saving into your

emergency fund, contribute to your 401(k) up to the company

match. If your company doesn't have a match, start putting 3%

into your 401(k). With the other 7% of the earnings you are

setting aside, start saving for a house.

Don't max out your 401(k) until:

You have an emergency fund

You have paid off your credit cards

You have bought a house or condo (or know that you either have

enough saved for a down payment, or that you will never buy a house.)

That means that if you are maxing out your 401(k) now and

don't have an emergency fund, stop maxing out your 401(k).

Does this sound like heresy? I'll say it again. STOP.

I recommend this because the number one thing you can do lower

your financial angst is to have an adequate emergency fund.

Grow up and stop living paycheck to paycheck. Adding to your

401(k) won't lessen your current angst, establishing an

emergency fund will.

What if you try this and, after a year, you haven't

accumulated any savings? In other words, what if you're

incapable of leaving the money alone? Cut up your credit

cards. Start paying for everything with cash. A colleague of

mine, Ken Robinson, has a terrific book that just came out

about how to start saving. It's called Don't Make a Budget.

If you can't figure out how to save, or if you try and you

just can't do it, get his book.

Sometimes people object to this advice. But Bridget, they

say, money in a savings account isn't doing anything. It's

just sitting there.

I tell them, instead of thinking your money is just sitting

there, think it's meditating. Your money is meditating so you

can relax.

Besides, these days, with the Internet, there are

high-interest savings accounts. I like INGDirect, and a lot of advisors I know recommend Emigrant Direct.

These are online savings accounts that make it easy to

transfer money from your checking account, are insured up to

$250,000 per account by the FDIC, and offer a higher interest

rate as part of their marketing strategy. The two banks I

mentioned have offered high rates for more than 5 years, so I

don't believe their interest rates are one-time teasers.

What's the difference? ING Direct is paying 1.3 percent now.

I saw a recent Fidelity statement showing a money account

earning .07 percent. Chase currently pays .01 percent for the

standard savings account. That means that if you have $10,000

in your savings account, you'd make $130 a year at ING Direct,

$7 at Fidelity, and $1 at Chase. At Chase, you could argue

your money wouldn't be doing much.

But one thing you know for sure is that it won't be going

down. There's some charm in that. People who have lost money

in the stock market plunge can see a lot of charm in that.

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