Stopping Retirement Contributions to Get Out Debt

There is a general consensus that when it comes to retirement contributions you should start early and never stop. But there may also be times when contributing is either undesirable or even impossible, and you ll need to take a retirement contributions time out . One of those situations is when you are in debt. It s hard to generalize advice on this topic; much depends on the type of debt that you have, how large the debt is, and what other resources you have to deal with it. Keeping that in mind, let s consider a situation where the debt level is impairing your life, and there are few options apart from your retirement plan to deal with it.

Photo by alancleaver 2000 via FlickrDebt Makes Wealth Building Harder

When it comes to making retirement contributions, debt is a form of competition. The most obvious is that debt payments reduce the amount of money you have available to contribute your retirement plan. While it s true that the earlier you invest the better, the amount of money that you contribute early on is also a major factor in your long-term success.

Reducing or eliminating your debt will increase the chance that you ll be able to make the largest contributions possible.

Debt has another influence that s not entirely financial. If you re trying to juggle both debt repayment and retirement contributions, life can get a bit unpleasant. You d be attempting to payoff past financial obligations (debt) and to fund future living expenses (retirement). All of that will compete with your efforts to live in the present. The potential is real that you will be living a life of high stress, which can also take a toll on your health. You will not be able to sustain that type of financial arrangement for very long without some sort of consequences.

In this case you might have to make a choice between either funding your retirement plan or paying off your debts.Dealing with DebtDelaying Your Retirement Plan

If you re just starting out in life and you have a lot of debt it may be in your long-term best interest to first concentrate on paying off your debts. You may not be able to do that with a large debt, like a student loan, but your retirement contribution effort will be both easier and more effective if you can eliminate any other debts that you re carrying.

It may be worth delaying contributing to your retirement plan for two or three years until you can at least eliminate your car loan and any credit card balances you have. Once you do, you ll have more money to contribute, as well as more money for whatever else you want to do in life.Taking a Break from Retirement Contributions

Sometimes debt occurs later in life. Though you may have been relatively debt-free in your 20s, having a house and a family may have caused you to rack up an uncomfortable level of debt. A retirement contributions time out for as long as it takes to payoff your debts can help you to turn the situation around.

If you ve already accumulated a large retirement portfolio at that point, halting your contributions for a time may not do as much damage as you might think. This is because you already have a large capital base that s earning investment income. If you are earning an average of 10% per year on your retirement portfolio, then your portfolio will continue to grow while you re busy paying your debts.

Though it s unfortunate that you might have to stop making contributions in order to payoff debt, it is better than letting your debts pile up or being force into liquidating your retirement funds to pay down debt. Once your debts are paid off, you can resume your retirement contributions, except that now you ll have more money to contribute.What You Should Not Do

A lot of people with debt liquidate their retirement plans, either partially or entirely, in order to get rid of debts. While this can feel right from an emotional standpoint, it s a complete disaster from the financial one.

Not only will the withdrawal of retirement assets be added to your income, and subject to income tax, but you ll also incur an early withdrawal penalty equal to 10% of the distribution. For many taxpayers, taxes and penalty can add up to 30% or more of the amount withdrawn from the account.

The better approach is to suspend retirement contributions, concentrate on paying off the debt, then resume contributions later under better financial circumstances. It s important to begin this process before your debt gets out of control. By taking a break from your retirement contributions you may avoid being forced into a position of needing to liquidate your plan at an unacceptably high cost.

Have you ever thought about the alternative to the liquidating retirement assets to payoff debt?

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