Should you save for retirement or a home down payment? And what about when a 401K match is involved?
20SF reader, Steph, writes in:
“I’m 26 and up until now have saved about 6% of my income to my 401k. I recently started a new job and was offered a free financial consultation at work. I told the adviser that I wanted to buy a house by the time I’m 30 and asked about how to save. She said that since I have such a tangible short-term goal that I should think about saving the money I would have otherwise put into my 401k. For the past few months I’ve been saving around $500 a month to put towards a house. Is this a smart thing to do? I am missing out on company contribution matching to my 401k but it isn’t much since I’m not vested etc. Do you have any advice? “
A little more context was needed, so I dug a little deeper on the match and vesting period, to which Stephanie responded:
“The company match between 0-5 years is $.50 for each dollar contributed up to 5% of compensation (5-10 years is $.75, 10 or more is $1.00). The vesting schedule is:
less than 2 years = 0%
after 2 years but less than 3 = 20%
after 3 but less than 4 = 40%
after 4 but less than 5 = 60%
after 5 but less than 6 = 80%
after 6 or more years = 100%”
Ahh… there’s the twist.
First – shame on your company for attempting to induce employee loyalty by giving out a shitty 401K match and then making you stay 6 FULL YEARS to get all of it (actually 10 years to get a dollar-for-dollar match). Companies should be confident enough in how they treat their employees that their 401K program vests immediately. The fact that they match so little and have a difficult vesting schedule is a big red flag, in my opinion. Pensions are a different story, but pensions are dead, so there’s no need to worry about that for most people. The only thing worse than vesting schedules like this are no match at all or a cliff vesting schedule (stay a minimum # of years, or you don’t get any 401K matching), so I guess that’s the silver lining. Got sidetracked there…
The vesting schedule definitely plays in to the answer here. But perhaps the most important variable here is a human element: how much do you actually like your new employer? And not how much you like them within the 3-6 month honeymoon phase, but how much you like them a year from now. If you see yourself with this employer for 5 years or more, I think it’s foolish to turn down the free 401K match. Here’s why…
1. You can always save for a house at a later time
But you can’t go back in time and get free money for your retirement. As time goes by, not contributing to your 401K and getting a free match cannot be undone. To divert funds away from your future self to acquire a material possession (albeit an important one) is something that your future self might be kicking your present self for doing.
2. If you can’t put aside 5%, maybe you shouldn’t be buying a house
Part of me thinks that if your cash flow is so tight that putting aside 5% to get the match vs. putting it towards home savings is an either/or proposition, then you’re definitely not at good enough financial standing to be thinking of buying a home. If you were in good standing, getting the match would be a no-brainer. What would happen if you bought the home, with zero margin for error, and then you lost your job or had a financial emergency? If there is enough cash flow to get the match – then there’s no reason not to.
On the other hand…
If you don’t plan on being with this employer very long or decide that much after the honeymoon phase wears off, then diverting those funds towards home savings might be the better route. Loyalty in the workplace is gone, and most people don’t even make it past 5 years in a job. But there are a lot of other variables at play (your monthly cash flow, how much you’ve saved already vs. how much a home in your geo costs, how much retirement savings do you already have, what is the price-rent ratio in your area, etc.).
Those are my thoughts.
Readers – what’s your take?
Are you debt free? Before you have kids or own a home get yourself to debt free living. Change your lifestyle to be as frugal as possible and put every last dime into paying off your debts. Then work on your retirement. Then work on buying a house. Of course this is a very simplistic view from my POV, but as someone who put every last penny into material possessions for most of my twenties I have the ability to have 20/20 vision while looking at my past.
OMG!!!! Get that employer match – now! Fully! You may think 5-6 years is a lifetime – ha! It goes by in the blink of an eye and with this economy you may well find yourself there a whole lot longer than it takes you to vest 100%. Have it automatically deducted – out of sight, out of mind and you will learn to live (easily) on what’s left of your salary. Once you’ve adjusted, start saving for that house – and do it aggressively. Interest rates are sooooooooooooooooooooo good right now, but creeping up (slowly). Best of luck and good for you for thinking like this at such a young age.
Wow, that is a crummy match system! Matching contributions tend to get overlooked in the interview process, and this is a good case to show why considering the match and vesting schedule is important.
Regarding the savings issue, I would recommend saving in your 401k before saving for a house. One important lesson I have learned is that a house (unless it is a rental) is not an investment, or at least not a very good one unless you get a screaming deal on it or can rent out rooms to more than cover your mortgage. You can borrow money for nearly everything except for retirement, and the mantra of retirement savings is save early and save often. Any 401k chart you read will usually show you the benefits of saving the same amount from your 20’s versus later, even just
10 years later). It adds up to big money if you can save on your 20’s.
I also agree with the poster above who said that if saving for a house or retirement is an either/or decision, then you probably aren’t in a financial situation ideal for buying a house. Buying a house by 30 is a great goal, but having your retirement already well on track will offer far more financial benefits for your future.
My two cents is to contribute up to the match in your 401k and then look to funding a roth (you have to review your tax status, but for people in their 20’s it is typically a good option). Cut back spending and see if from there you can start saving for a house while still funding you retirement.
Ok, I had this same issue at my previous employer. It was a big four accounting firm, and they had an astounding turnover rate (3 years after beginning, I only know 1 out of 35 people who are still working there). That is part of why they have such a crummy vesting schedule, is because they know you’ll leave, and want to keep as much of your money as they can.
So the question is, are you willing to set that money aside and only get an extra 2.5% of your compensation put in from your company for your 5%, AND have to knowingly stay there for 6 years? What’s the turnover like? If everyone usually leaves in 2-3 years, you’re now only going to get 40% of that 2.5%, or now 1% of your compensation, in return for locking your money in.
Honestly… I’d go with a Roth IRA if you haven’t maxed one out. You can pull your principal out later to buy the house, but you can earn money on it as it sits in a retirement account. I think the perk of being able to pull the principal out to buy a house is worth the 1%-2.5% of your compensation premium you’d be paying. If you found an employer who fully matches 100% with an easy vesting period, I’d say do that, but this plan sounds terrible and makes me wonder if there’s high turnover at your company.
You didn’t indicate what your income is, but if the 6% that you were previously putting into the 401K is equal to the $500 a month that you are saving for a house, then that works out to $100K a year. If you are someplace with an extremely high cost of living, then I could see the reason that $500 is a limit. Otherwise, you should have enough to put money away for an emergency fund and a down payment and your retirement.
One thing about saving for a down payment that people don’t take into account is the liquidity of that money in case of emergency. On the other hand, with a company that has a normal (immediate) vesting in the 401K and investment options that generate a reasonable rate of return, the 401K can be considered the emergency fund in case of layoff because the employer match would more than make up for the tax penalty for early withdrawal.
I’m interested in how the answer to this question changes when:
1) I have no 401(1)K match, but instead have been putting money in a Roth IRA for the past 5 years (I’m 26, have been contributing since I was 21- not a lot, but every month, even when making ~$800/month in college and Americorps.)
2) Given that Roth IRA’s can be pulled out tax-free for first-time home purchases, should I simply contribute to that fund? The only downfall I see to that is the temptation to pull out more than I should for a house. There’s a chance I qualify for a matched IDA savings account, which would give me a 3:1 return on my savings up to $3,000 over 3 years, but I HAVE to use it on a home, or I get no interest whatsoever. Both options annoy me slightly as I can only use the money on a home for either option, not biking around the world on sabbatical or something similar.
3) I have no debt & have a 4-month emergency fund, but I only make $30K/year.* This is enough for my frugal lifestyle that I save 28% of my income currently and I donate 5% to local non-profits.
4) The purchase price:rent*12 ratio is 11:1. I can find 1-bedroom condos for slightly more than I pay in rent each month in my area.
I’d love to own my own home by the time I’m 30, as I’m tired of not being able to paint my walls/park my bike inside my apartment plus throwing money away on rent. But I don’t want to screw myself over for future retirement by diverting my generous retirement savings to a home purchase. If I split the amount I save into two buckets, it would take me twice as long to save for a house, and interest rates and home prices are only rising.
*I love my job at a local non-profit, and this is a reasonable income in my sector/location. Changing jobs for more income is not currently in the cards.
Certain things don’t work by percentages, but rather by absolute costs. For example going to the doctor for some specific problem has a certain cost, not some percentage of your annual income. Your four month emergency fund is possibly too small to account for a potential problem.
As far as retirement goes and owning your own home, if you buy no more than would rent, then you are generally taking ownership of your basic living requirements. Comparing the costs of ownership to the costs of rental over the long term, owning your own place is usually the way to go. With a fixed rate mortgage, you lock in the largest cost inflation so that over time your monthly costs of mortgage, taxes, maintenance, and the like are less than what inflation does to the rental costs of a unit. You then have more money to invest for retirement, and even more so the day the mortgage is paid off.
You might also want to go for a longer term mortgage, even if you have to pay an extra .5% so that the REQUIRED monthly payments are less. You can always pay more than the required minimum but a lower monthly required payment can be thought of as a form of insurance for any period when you are between jobs. Or you can increase you emergency fund to include a years worth of mortgage payments.