Is It Ever a Good Idea to Max Out Your 401(k)?

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The earlier you start saving for retirement and the more you contribute, the better. But should you max out your 401(k)? Whether maxing out your 401(k) is a good idea really depends on your personal financial situation.

The maximum amount you can contribute to your 401(k) is currently $19,000 a year if you are under age 50, and $25,000 if you are 50 or older. Once contributed, this money usually can’t be withdrawn until age 59½ without incurring penalties.

If you stash away this money now, you’ll be giving up part of your income and possibly making it more challenging to achieve other financial goals, such as saving up to buy a house or paying off your student loan debt. Still, you want to make sure you have enough cash saved to retire when you want to.

Should I max out my 401(k)?

There are a number of exceptional reasons to consider maxing out your workplace retirement account if you’re financially able.

As a baseline, you should at least make sure you’re saving enough to secure your entire employer match, if your workplace offers one. This match is a specific amount of “free money,” usually offered as a percentage of your own contribution, that your employer might offer to incentivize you to save for retirement.

But reaching your retirement goals may require contributing beyond your employer match. Alex Caswell, a financial advisor at RHS Financial, said three main reasons that people usually aim to maximize their 401(k) include:

  • Saving enough to actually retire one day
  • Reducing taxable income to save on taxes
  • Growing wealth on a tax-advantaged basis

Additionally, most people drastically underestimate how much they’ll need to retire one day, and many forget that retirement could last up to 30 years or even longer, Caswell said.

“Somehow you will need to make a fraction of your annual income grow and accumulate to the point where it can provide for you fully every year,” he said. “When you think about it from this perspective, it becomes very clear how important it is to contribute as much as you can.”

With all this being said, stashing $19,000 in your 401(k) each year can be easier said than done. While saving for retirement should be a financial priority, it shouldn’t necessarily come at the expense of other important financial goals, like building up an adequate emergency fund or paying off high interest debt.

You also don’t necessarily have to do all of your retirement saving in your 401(k) plan — especially if it has high fees or limited investment options.

Financial goals to complete before you max out your 401(k)

Depending on your salary and financial situation, it may make sense to check off some important to-dos before you start maxing out your 401(k). If you’ve already crossed all of these off your financial to-do list, that could also be a sign that you’re well-positioned to max out your 401(k).

Here are some of the most important goals you should consider when weighing whether you can realistically afford to max out your 401(k).

Building up an adequate emergency fund

Roger Whitney, host of the podcast Retirement Answer Man, says that it’s important to build up an emergency fund before you start maxing out your retirement fund. “Think of an emergency fund as the financial airbag of your life,” he said.

Having an emergency fund can give you financial options when anything unexpected comes up and help you keep your long-term assets for the long term. If you don’t have an emergency fund, you may be forced to deplete your resources if you face a job loss or a financial emergency.

How much should you save? Caswell suggests saving three to six months of expenses in a “safe and liquid bank account,” such as a high-yield savings account.

Paying off high-interest debt

You may also want to consider paying off high-interest debt before you max out your 401(k) entirely, advised financial planner Brandon Renfro.

If you have high-interest credit card debt, for example, it may be a good idea to go ahead and get that paid off first, he said. That’s because the average credit card interest rate is nearly 17% as of the date of publishing, meaning you’ll pay a lot in interest each month if you carry this debt over the long term instead of prioritizing paying it off.

Purchasing an adequate amount of life insurance

Make sure you have enough life insurance coverage to provide for your family if you were to suddenly pass away.

This shouldn’t be too difficult considering how inexpensive term life insurance coverage can be. Still, if you’re stretching yourself too thin to max out your 401(k), it might be tough to add another monthly bill.

Purchasing enough disability insurance coverage in case you’re unable to work

The importance of disability insurance is also worth taking into consideration when deciding whether to max out your 401(k). You should purchase enough disability insurance to provide coverage if you wind up being unable to work for six months or longer, said financial planner Ryan Inman.

Remember that your 401(k) funds can’t be used to replace your income if you cannot work for some reason without paying a hefty penalty. Disability coverage, on the other hand, can help you pay your bills and living expenses until you can get back to work.

Saving money in a health savings account, or HSA

According to financial advisor Matthew Kircher, health savings accounts (HSAs) offer one of the best tax-advantaged ways to save for high-income individuals.

“This is the only triple-tax-free option available that provides an upfront tax-deduction, tax-deferred growth and tax-free distributions,” he said.

The key to maximizing the HSA is to pay all actual medical expenses out of pocket, with the idea that you keep adding to and growing your account. You do have to have a high-deductible health plan to qualify for an HSA, however.

In 2020, this means a deductible of at least $1,400 for individuals (up from $1,350 in 2019) or at least $2,800 for a family (up from $2,700 in 2019). Maximum out-of-pocket amounts also apply to high deductible plans, and in 2020, your maximum out-of-pocket amount can be no more than $6,900 for individuals ($6,750 in 2019) or $13,800 for families ($13,500 in 2019).

While individuals and families could contribute up to $3,500 and $7,000 to HSA accounts in 2019, respectively, those figures will rise to $3,550 for individuals and $7,100 for families in 2020.

Save up to purchase your first home

Depending on your situation, you may want to prioritize homeownership. If you’re spending a lot of money on rent right now, for example, being able to purchase a place of your own could help you stop renting and start building equity.

“If homeownership is a goal of yours, you may want to get that taken care of before you start maxing out your 401(k),” Renfro said.

When you should max out your 401(k)

While you’ll want to balance your other financial goals, there are situations in which maxing out your 401(k) might be a good idea. You may want to consider maxing out your 401(k) if:

  • You earn a lot and want to reduce your tax bill. Terms may apply.
  • You want to give compound interest a chance to help your money grow, tax-deferred.
  • You’ve achieved some of the important non-retirement goals we’ve outlined above.

In addition to making sure you have enough saved to retire, the tax benefits of maxing out your 401(k) are real.

“Contribution to a regular 401(k) doesn’t get counted toward your income,” Caswell said. “If you are in a high tax bracket, every dollar you manage to protect from taxes will increase the power of that money to grow your wealth. At an annual contribution limit of $19,000, maxing out your 401(k) is one of the most powerful ways to reduce your tax bill.”

And, as we noted, don’t forget about the advantages of letting your money grow in a 401(k). All investments in your 401(k) grow tax-free.

“All the gains, dividends and interest you will incur year after year will be tax-free,” Caswell said. “This is unlike a regular brokerage account where you will receive a 1099 at the end of every year and be saddled with a tax bill.”

Other options besides maxing out your 401(k)

Whether or not you decide to max out your 401(k), there are plenty of other investment options to consider that can also help you to retire on your own terms. You may consider saving for retirement in other places as well, especially if your company’s 401(k) plan carries high fees or lackluster investment options.

Invest in a Roth IRA

According to Renfro, another retirement account option you may want to consider is a Roth IRA, which lets you invest for retirement with after-tax dollars. One strategy is to save enough in your 401(k) to get the employer match and then put anything you want to save above that amount in a Roth IRA, said Renfro.

“Saving in a Roth IRA in addition to a 401(k) can diversify your tax liability and help lower your overall tax rate when considered over multiple years,” Renfro said.

In 2019, most people can contribute up to $6,000 to a Roth IRA. If you’re age 50 or older, you can contribute up to $7,000.

Contribute to a traditional IRA

If you have the option to contribute to a traditional IRA, you may consider it before maxing out your 401(k). While 401(k) accounts are a great savings vehicle, they can be restricted in their investment options,.

“If you are looking for more control of your investment strategy, then you may consider saving in an IRA once you have taken full advantage of the 401(k) match,” Caswell said.

Note that the same contribution limits apply to traditional IRAs as Roth IRAs, and that the limit applies to both accounts combined.

Open a brokerage account

If you’ve already maxed out tax-advantaged retirement savings accounts like your 401(k), you can also consider opening a taxable brokerage account with any firm that offers one, such as Vanguard, Fidelity or Schwab.

Inman says that, while a taxable investment account won’t provide any tax savings, “it will provide another pool of assets to provide you with income in retirement.”

The bottom line

At the end of the day, having enough income in retirement is the underlying goal anyway, right? By contributing to a 401(k), simultaneously pursuing other financial goals and letting time and compound interest do their work, you should be well on your way to a secure financial future. Whether you decide that maxing out your 401(k) is a good idea to get there ultimately depends on your financial situation and other financial goals.

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Holly Johnson
Holly Johnson |

Holly Johnson is a writer at MagnifyMoney. You can email Holly here

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