Q: I am a 24-year-old mother of two, and I'm getting a divorce. My salary is about $50,000 a year, and I receive no child support. I plan to return to school and will probably make only about $20,000 once I cut back my work hours. I now put 6 percent of my income into my 401(k), adding a percentage point per year. Should I keep putting money into my 401(k), despite my limited income? Or should I wait until I finish school?
A: I wish I could bottle up your spirit and share it with the world. After reading your first three sentences, I was sure you would ask how you could make it as a single parent on one income that is dropping 60 percent. But instead you're focused on building security. That tenacity tells me you can do anything you set your mind to.
But you need to be realistic. On $20,000 a year, you will already be stretched thin. So please don't shortchange basic needs to keep saving for retirement while you are in school. Look at school as a big part of your financial plan: By upgrading your skills, you give a boost to your future earning power. When you're back working full-time, you can refocus on retirement investing.
But if you seriously think you can save for retirement and support your family while you're in school, here's my strategy: As long as you have a large emergency savings fund that can cover eight months of living expenses, keep investing in a 401(k) if you get a company match. Maybe it can't be 6 percent of your salary next year (that would be $1,200 of $20,000), but even at half that, you would benefit from the company match.
If you don't have an emergency savings fund, or your employer doesn't offer a matching contribution, skip the 401(k) while in school and invest in a Roth IRA . It has no tax or penalty if you dip into your contributions to cover an emergency. Only your Roth earnings would be hit with a tax, plus a 10 percent penalty for an early withdrawal. So your Roth could do double duty: When things go well, it serves as a retirement account; in times of trouble, you can pull out your Roth contributions without tax or penalty. Any money you invest in a Roth should go into low-risk investments, such as a money market fund, CDs, or short-term Treasury bills. Once you're out of school, you can move your investments to stock exchange-traded funds or mutual funds; over the long term, stocks will help you earn inflation-beating gains. Over the short term, they are too volatile to use for a quasi-emergency fund. Good luck!