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In difficult economic times you might be wondering if you should continue contributing to your 401k or if it would be better to have a cash reserve instead. The following article addresses this concern while outlining the reasons to continue or even increase your contributions.

Excerpts taken from indystar.com on September 13, 2009.

When making decisions about saving, the first question to ask is, “For what purpose is the money earmarked?”

If this savings is for retirement, favor the 401(k) plan. It offers many significant advantages, even during a difficult recession.

First, there are tax advantages. If the dollars you deposit are pre-tax deposits, you’ll save on taxes this year by making deposits. If you choose a Roth 401(k) plan deposit option, you will create tax-free income in your retirement.

Second, you may pick up some free retirement funds from your employer. Although some employers have suspended or reduced their profit-sharing and matching deposits, most haven’t. These deposits come to you without current taxation requirements, which further maximizes their value in growing your retirement nest egg. At a minimum, always deposit the amount your employer will match.

Third, deposits are made through payroll deduction, so saving happens automatically. You’ll buy when prices are low as well as high, which can lower your average cost over the long term.

Despite the discouraging investment results in 401(k) plans for the past few years, they are still a good place to save for the retirement you hope for.

It is in times like these that it is most difficult to remain disciplined with your investments. However, it is also in times like these that it is most important to remain disciplined.

If you still plan to retire someday, you should continue your 401(k) contributions regardless of short-term market or economic conditions. In fact, it is probably a great time to increase your contribution level, as the equity markets are still well off their highs.

One possible reason you might temporarily reduce your contributions is if you don’t have an adequate emergency fund of three to six months’ worth of living expenses. In this case, reducing 401(k) contributions should be only temporary until you build a sufficient emergency fund.

However, if your employer matches your contributions, you don’t want to reduce your contributions below the level that is matched.

If you are within three years of retirement, it might be wise to accumulate some additional “cash” savings that could be drawn upon in retirement to meet your living expenses. If the equity markets happen to be down in the year you retire, you could draw upon those cash reserves instead of having to liquidate investments.

But this cash savings can be done within the 401(k), so it doesn’t justify discontinuing your contributions. Instead, a reallocation of the way those contributions are invested may be in order.

Investing in your 401(k) versus saving cash should never be dictated by the current market conditions. Investing in a 401(k) or other “pretax” account is most prudent when savings are needed to fund your retirement and if your current tax rate is higher than your forecast rate in retirement. One exception is taking advantage of an employer’s matching contributions whenever possible.

Also, if you’re in a cash crunch, don’t cancel your 401(k) contributions. Instead, reduce them to the minimum amount. Otherwise, you may have to wait for the next open-enrollment period.

Last, you should review your portfolio and retirement plan. Ensure you are allocated according to your risk tolerance and time horizon, and double-check to make sure you’re on track to reach your retirement-funding goal.

Visit indystar.com to read the entire article.