Dear Dave,
My husband and I heard about your plan, but we're not sure what to do next. We have between $400,000 and $500,000 in a 401(k) for retirement, but we don't have any other savings. We're both in our 40s, and the only debt we have is our house, so what should we do about Baby Steps 4 and 6?
— Mary
Dear Mary,
Overall, you two have done a great job with your money. 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 3 to 6 months of expenses in an emergency fund. This is money set aside strictly for emergencies. The problem right now is if you have a real emergency, you may have to cash out your 401(k). If you do that, you're going to be penalized 10 percent, plus your tax rate. That's a real kick in the teeth just because you didn't do things in the right order.
My advice is to temporarily stop your 401(k) contributions until you get a fully funded emergency fund in place. By temporarily, I mean 6 to 8 months at most. That way, you'll be covered when life happens without having make a big dent in your retirement savings.
—Dave
