Stop 401k deductions to pay debt is this smart?

Question

My partner and I are considering stopping all 401k deductions (MAXED YEARLY) to fund debt payoff. I am not sure if this is the correct approach and looking for advice?

We currently have a 2 rental properties and produce around 7k annually in combined profits after all expenses. With combined income that will exceed

135k without deductions we rely on the  39k 401k deduction to lower are tax bracket yearly.

We see the value of getting debt free to accumulate cash to purchase property. On the other hand we do not want to have to give that cash to the irs in additional taxes owed yearly.

Any advice from the BP community would be appreciated. Also if there are any Connecticut investors out there that can share their tax professional contacts that would be great.

Dmitriy Fomichenko · Answer

@Lee Prete

If your employer matching your contributions you should contribute up to the match. This is free money and offer immediate guaranteed return. For example, if they match 50 cents for every dollar that you contribute up to certain amount, that means that if you contribute $1,000 they will match it with $500, which means 50% return on your money. I'm sure this is a lot more than the interest you are paying on your debt, correct?

Lee Prete · Answer

Greeting Dmitriy,

I am going to continue to contribute the required amount to make sure the the employer match is still coming into the account.

The interest on the debt is at 13.99 percent.

What I was worried about was making to much money and not having enough deductions to take me down a tax bracket.

Accelerating debt pay off is a great thing but if I am going to have to give the irs an extra 12  percent I might be better of finding a different way to accomplish this payoff.

Respectfully,

Lee

Mat O'Grady · Answer

@Lee Prete Typically, I would invest more into my retirement than paying of debt, but the interest rate on the debt is high. I would take the company match then put all my cash towards that debt. Paying down the debt would be a 13.9% return which is historically higher than the average return of the stock market.

Another option could be to try and refinance the debt to a lower interest rate and then you wouldn't have to focus on paying it down.

Ryan Allison · Answer

@Lee Prete I'm not a financial advisor or accountant but here's what I would do....

Contribute the required amount to get the maximum contribution to 401k from your employer.

Take as much of a dent into that interest as you can or look for a re-finance altogether.  14% in this environment is very high.

I would not sweat being on the fringe from one marginal tax bracket to another.  Take a look at this article.  https://www.cnbc.com/2021/03/1....

Dmitriy Fomichenko · Answer

@Lee Prete

You should work with tax strategist (not just a tax preparer) to plan how to minimize your tax liability using various strategies. Real estate and 401k contributions are just two components of the overall strategy, you need to evaluate all available options. Do you have one?

Lee Prete · Answer

Greetings Ryan,

Thanks for the reply I am going to proceed with the minimum to make sure the company match is going into the account every year at it highest amount possible.

You are right that the capital I could be saving is better diverted In to more lucrative endeavors such as additional properties. The only negative I foresee is being bumped into a 12 percent higher tax bracket if I am to not be able to deduct the 401k monies. I will have to find an accountant that can help we work the numbers thanks for your insight.

Respectfully,

Lee

Lee Prete · Answer

@Dmitriy Fomichenko

Ryan Allison · Answer

Probably goes w/o saying but if you have a company match on the 401k, i obviously wouldn't contribute less than the value of the match.

What's the interest rates on the debt?

Personally I contribute SLIGHTLY more my company's match and take the extra cash to do what I want with it.  Of course you want to take advantage of the company's contribution towards retirement. it's a benefit for a reason.

I see the value of deferring the tax liability by contributing more than a company's match annually towards a 401k..... but my perference  is not to tie my capital up until i'm 65 & would rather do other investments (i.e. real estate).

Stop 401k deductions to pay debt is this smart?

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