Reducing your 401(k) contributions might seem like a good idea in the current economy. With so many uncertainties from tariffs to recession talk, you can’t be blamed for wanting to pull back, hunker down and save as much as possible.
You wouldn’t be alone. It’s something weighing on the minds of many investors.
“It’s the first time in a while that we are having those questions asked by clients,” says Daniel Milan, founder, managing partner and CIO at Cornerstone Financial Services. “If I reduced it (my 401(k) contributions) or made a change, how would it affect my long-term financial roadmap?”
401(k) Contribution Reduction Dangers
1. It Limits Your Lifetime Earnings Potential
Save early and often is the mantra for many financial advisers for good reason. Due to compounding, the more you save and the longer you’re invested, the greater your balance will be over time.With compounding, interest earned on an investment is added to the principal amount, then future interest is calculated on this new, larger amount. This process happens repeatedly over a set period, often months or years, depending on the investment.
Take a 50-year-old individual with $1.24 million in her 401(k) who contributes $27,500 a year ($23,500 is the 2025 yearly limit, plus up to $7,500 in catch-up contributions for those age 50 and older). Assuming a modest growth rate of 1.26 percent, her balance will grow to $4.72 million after 20 years, says Milan.
If she reduces her contributions to $12,000 a year, her balance after 20 years will be $4.16 million, $600,000 less. “That’s not a small number,” says Milan.
What about this: Boldin, the financial planning tool company, ran two scenarios for a married couple aged 45 with a 10 percent employee contribution and a 3 percent match. If one spouse’s contribution were stopped, the chances of saving enough for retirement would fall by 5 percent, and the estate would decline in value by $2 million at longevity age.
The longer you reduce contributions, the bigger the impact. If you reduce your contributions for six months, it won’t derail your retirement savings plans as much as if you kept a lower contribution rate for years.
2. You Settle for Less
The phrase “old habits die hard” couldn’t be truer. Once you set something in motion, it’s hard to come back. That’s particularly true when it comes to your 401(k).If you reduce your contribution rate, chances are that will become your new baseline, which means you’re selling yourself short. The purpose of a 401(k) plan is to pay yourself first so you can live comfortably in retirement.
3. You Miss out on Growth Opportunities
Buy low and sell high is the goal of most investors, but in volatile markets, many tend to do the opposite: Sell low and buy high.If the markets have got you spooked into considering reducing your future 401(k) contributions, think again.
History has proven that stocks that go down tend to go back up. If you reduce your contributions when stocks are in decline, that’s less money that can benefit when the markets appreciate again.
4. You Leave Free Money on the Table
To reward you for saving for retirement, many companies offer a matching component with their company-sponsored 401(k)s. The employer commits to match a percentage of your contributions, typically, 3 percent to 4 percent.If you lower your contributions below the 401(k) match, you’re leaving free money on the table. Less money in your 401(k) means less money that can benefit from compounding.
If you’re determined to do it, Milan says to be mindful of the match.
5. It Could Push You Into a Higher Tax Bracket
If you’re on the cusp of being in a higher tax bracket, contributing less to your 401(k) might push you over the edge. The income not going into your 401(k) tax-free will count as taxable income.6. It Could Force You to Work Longer
You might plan to retire at 65 or 66, but that roadmap could veer off course if you reduce your 401(k) contributions for an extended period. It could create a retirement shortfall that will require you to work longer or change your lifestyle when you exit the workforce.When It Makes Sense
Reducing your 401(k) contributions should be a last-resort lever you pull and only use in extreme cases. If you can’t pay your bills or have a lot of debt, it might prove prudent to tackle that first.“When you are starting on a path of financial wellness, the first thing to do is make some income and pay expenses on time, every time. The next goal is to have an emergency fund,” says Gates.
“After that, the goal should be to pay off high-interest debt before saving for retirement. If you can’t pay your bills on time and have high-interest debt, pause contributions until you’re at the right place.”
