Article updated August 10, 2017.
One of the first things many veteran cops tell rookies is to immediately max out their deferred compensation contributions. I respectfully disagree. That may sound like blasphemy, but there is a method to the madness.
Saving for your retirement above and beyond your pension is an excellent idea; however, when taken out of sequence, it can actually have a detrimental impact on your current financial situation.
Conventional wisdom will tell you that contributing as early as possible to your retirement is a no-brainer. While that statement is sound conceptually, “as early as possible” needs to be more clearly defined.
Stop the Shotgun Approach
In his book, The Millionaire Next Door, author Thomas J. Stanley asked a number of millionaires their number one tactic in becoming millionaires. The overwhelming answer was to get out of debt and stay out of debt. According to ehow.com, the average amount of personal debt per person is a little more than $50,000.
What does that have to do with your personal financial situation and contributing to your retirement? It comes down to taking a focused rather than shotgun approach.
Consider this analogy: If you stand with a shotgun loaded with 00 Buck at the 40-yard line on the range and you’re told to consistently hit a target center mass without fail, what’s going to happen? Is that even remotely possible? Of course it’s not. However, if you stand at the same line with a scoped long gun, will you able to consistently reach out and center punch that target? Damn straight, you will.
If you find yourself in debt and you’re contributing to deferred comp as well, you are approaching your financial targets with a shotgun from a significant distance. Sure, you’re making some progress, but not the kind of progress you could be making if you approach your finances with purpose.
Getting Out of Debt
With focus and intentionality, it’s more than possible to get out of $50,000 in debt in two to three years (and that’s a very conservative estimate).
Let’s assume you are maxing out your deferred comp contribution. According to the IRS, the contribution limit is $18,000 per year. That equates to $1,500 per month. Of course, that is pre-tax dollars, so you wouldn’t be bringing home the whole $1,500. Conservatively, let’s assume $1,000 would make its way to your checking account.
If you were to stop contributing to retirement for that period and apply $1,000 a month to your debt, you’ll practically cut your debt in half in two years. This also assumes you aren’t cutting expenses or picking up overtime or creating income with a second job.
If, however, you do cut expenses, bring home extra money, and/or sell some stuff (garage sale, Craigslist, Ebay, etc.), you can supercharge your journey to becoming debt free. The sooner you eliminate your debt, the sooner you can return to contributing to deferred comp.
During the period you stop contributing and focus on getting out of debt, are you losing out on the advantages of pre-tax donations through your deferred compensation? You absolutely are. The flip side of that is you’re also paying off debts that most likely have exorbitant interest rates. You’ll be making short-term sacrifices for long-term gains.
When you are out of debt, you are clear to max out your contributions without having the additional worry of being in debt. The concept of compound interest will get you back in the game before you know it.
When there is no crippling debt hanging over your head, it’s amazing the impact it has not only on your financial life, but your home and work lives as well. Personal finance is so much more than numbers on a page. It’s more about behavior than it ever was about head knowledge.
Laser focus and intentionality will help you achieve your financial goals.
