Reducing your 401(k) contributions may 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. If I reduced it (my 401(k) contributions) or made a change, how would it affect my long-term financial roadmap?” says Daniel Milan, founder, managing partner and CIO at Cornerstone Financial Services.
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Reducing 401(K) contributions when stocks are down and costs are rising is an option, but it's not the best one to choose. It can cause irreparable harm to your retirement savings. Here’s how.
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 are invested, the greater your balance will be over time.
With compounding, interest earned on an investment is added to the principal amount, and then interest is calculated again on this new, larger amount. This process happens repeatedly over a set period, typically 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 over 50). Assuming a modest growth rate of 1.26%, 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.
Or what about this: Boldin, the financial planning tool company, ran two scenarios for Kiplinger.com for a married couple aged 45 with a 10% employee contribution and a 3% match. If one spouse’s contribution were stopped, the chances of saving enough for retirement would fall by 5%, 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 or forever.
“If it’s short-term in nature, that doesn’t have a major effect, but if something becomes the new normal or habitual, it can have a significant effect over ten or twenty years because it decreases compounding,” says Milan.
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. After all, the whole purpose of a 401(K) plan is to pay yourself first so that you can live comfortably in retirement.
“If you contribute less, you are losing that habit,” says Nancy Gates, lead educator & financial coach at Boldin. “When you get a job, you are automatically enrolled up to a 3% or 4% match. You are not even thinking about it. If you stop, you may never go back to it.”
3. 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 and are why you’re 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.
Stocks recouped losses and then some after the Dot.com boom and bust, the Great Recession and COVID. Even today, markets have recovered somewhat from the steep sell-off seen earlier this spring. Plus, if you stay invested when markets are depressed, you can get more shares for your money.
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% to 4%.
If you lower your contributions below the 401(K) match, you are leaving free money on the table. Plus, you know the drill: less money in your 401(k) means less money that can benefit from compounding.
If you are determined to do it, Milan says to be mindful of the match.
“At the very least, we try to draw a hard line at whatever the match is,” says Milan. “Once you go below that, even in the short term, you are giving up free money that is part of your compensation package.”
5. It could push you into a higher tax bracket
If you are on the cusp of being in a higher tax bracket, contributing less to your 401(K) may push you over the edge. The income not going into your 401(k) tax-free will count as taxable income.
Gates says that if you still want to reduce contributions, make sure you aren’t lowering it so much that you have to pay more taxes.
6. It could force you to work longer
You may 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.
Take Milan’s example of the person who contributed $12,000 per year instead of $27,500 and ended up with over $600,000 less by the time they retired. If you have $600,000 less in your 401(k), will you still be able to live comfortably in retirement? If not, you may be forced to delay retiring for a year or two or more.
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 may 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.”
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