Why Dave Ramsey Is Wrong About ‘Pausing 401(k) Contributions’

Dave Ramsey has guided millions of Americans through their struggles with debt, but his advice to press “pause” on your 401(k) plan while you pay off debt could cost you tens of thousands of dollars that you’ll never get back.

Pausing contributions results in missing out on your employer match, causes you to miss the market rebounds that often follow market downturns, and derails the automatic savings that keep you on track toward retirement. The financial advisors we talked to say there’s a better way.

Why pausing can be such an expensive mistake?

Here’s what you could lose if you stop contributing to your 401(k):

• You are losing free money: Employer matches are real compensation, typically 4% to 5% of salary. “It may make sense to contribute enough to get the match even when carrying high-interest debt,” said David Tenerelli, certified financial planner and financial advisor at Values ​​Added Financial. Investopedia.
• You miss compound growth: Two lost years in your 30s could mean tens of thousands less in retirement.
• Problems opting out of Automatic savingAutomated 401(k) contributions are a form of disguised dollar-cost averaging, where more shares are automatically purchased when prices are lower. Opting out invites exactly the kind of timing mistakes investors should avoid.

Two goals, one game plan

Paying off high-interest debt shouldn’t be your only focus.

“Paying off high-interest debt and saving for the future…do not have to be mutually exclusive,” Tenerelli said. While paying down your debt aggressively can work, he said finding the right balance often helps you build more momentum on both fronts at once.

Brenton Harrison, a certified financial planner and founder of New Money, New Problems, agrees that the answer depends on your time horizon. ““If the high-interest debt is paid off within a short period of time, it does not worry me to the extent that I would recommend the client stop superannuation contributions,” he said.

“When I see balances staying the same or increasing year over year, and worse yet, if a client doesn’t have emergency reserves, it implies they are putting money toward a stable retirement when their current situation is otherwise,” Harrison said.

How to do both at once

Here is a practical sequence that will enable you to save and pay:

1. “Contribute enough to your 401(k) to ensure you receive the maximum employer matching contribution (if offered), and direct any available surplus cash toward paying down debt,” Tenerelli said. This way, you’re not walking away with free money while you tackle the debt that’s costing you the most.
2. Dump all available excess cash onto high-interest balances, using avalanche or snowball methods.
3. As your debt decreases, you can increase retirement deferrals to make up the ground, aiming for a rate of 12% to 15%.

Smarter moves for special situations

When the employer does not offer a match: Tenerelli suggests focusing on paying off your debt when the interest rate is more than 7% to 12%. Harrison puts this idea in terms of opportunity cost: a 20% credit card payment exceeds typical market returns.

When money is tight: You can restructure your debt with a low-interest loan or temporarily reduce your spending, then use automatic top-up features to boost contributions.

When you need to borrow: As a last resort, a 401(k) loan can help pay off high-interest debt when no other options are available. The loan interest goes back to your account, and there’s no credit check needed.

Harrison provided an example: “I had a client whose credit card debt exploded due to a series of largely unavoidable events.” Their monthly bills and high interest rates made paying on their income alone very difficult, and their low credit meant they were unable to get a personal loan or balance transfer. “Using a 401(k) loan allowed them to lower their interest rate and pay themselves off with a manageable monthly payment and repayment period,” he said.

Just keep in mind that you contribute to your 401(k) with pre-tax dollars, but any loan or debt repayment is made through after-tax income. In other words, you’re paying back that borrowed money with money that’s already been taxed — an important difference in what it costs you. The 10% early withdrawal penalty only applies if you leave your job or default, and the ordinary income tax due on the distribution is the same as the tax you’ll eventually pay in retirement.

Both Tenerelli and Harrison cautioned that any approach should take into account your individual situation, including your cash flow, whether your income is stable, whether you have emergency savings, and understanding tax considerations.