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Dave Says: Lay the Foundation First

by | Jan. 24, 2012

Finances

Dear Dave,

We’ve read about your plan, and we’re in pretty good shape financially, but we don’t know what to do next. We have $400,000 in a 401(k) for retirement, but we don’t have an emergency fund or any other savings. The only debt we have is our house. What should we do about Baby Steps 4 and 6?

Mary

Dear Mary,

You guys have done a great job of saving for retirement and staying out of debt. Let’s go over the Baby Steps you mentioned. Baby Step 4 is putting 15 percent of your income into Roth IRAs and pre-tax retirement plans. Baby Step 6 is paying off your home early.

The thing that worries me is you’ve completely skipped Baby Step 3, which is having three to six months of expenses in an emergency fund. This is money set aside strictly for emergencies, not vacations, toys or a new car. The problem right now is if you have a real emergency, you’ll have to cash out your 401(k). If you do that, the government’s going to penalize you 10 percent, plus your tax rate. That’s about a 40-percent kick in the teeth just because you didn’t do things in the right order!

Again, you’re in pretty good shape overall, but in building your financial house you’ve put the roof on before you’ve laid the foundation. If I’m you, I’m going to temporarily stop my 401(k) contributions until I get my emergency fund fully loaded. By temporarily, I mean six months at most. That way, you’ll be covered when life happens without having to sacrifice your retirement savings!

—Dave

For more financial help, please visit davesays.com.
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