Should I Max Out My 401(k)?

If you’re ready to increase your retirement savings, congrats. That’s a huge step towards the future you envision. But you might be asking, “Should I max out my 401(k)?”

The answer depends on your personal financial situation.

Before you decide to hit your 401(k)’s annual contribution limit, it’s important to weigh the impact those additional contributions can have on your other financial goals.

Should I max out my 401(k)?

There are a number of exceptional reasons to consider maxing out your 401(k).

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 money usually offered as a percentage of your own contribution, that your employer might offer to incentivize you to save for retirement.

For example, if your employer matches 100% of up to 3% of your total annual contributions to your 401(k) plan and you’re not deferring at least 3% of your salary into the plan, you’re leaving free money on the table.

But reaching your retirement goals may require contributing beyond your employer match. Some of the reason you might want to max-out our 401(k) contribution include:

• Increasing your retirement income.
• Reducing taxable income.
• Reaping the benefits of tax-deferred growth.

However, maxing out your 401(k) is easier said than done for many people. For instance, the 2022 annual contribution limit to a 401(k) for employees is $20,500 for those under 50. Those 50 and older can contribute an additional $6,500. But for various reasons, you might find that deferring $27,000 from your salary into your 401(k) isn’t doable.

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

Ways to save before you max-out your 401(k)

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

Build up your 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 dip into your retirement savings if you face a job loss or a financial emergency.

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

Pay off high-interest debt

You could also consider paying off high-interest debt before you max out your 401(k).

If you have high-interest credit card debt, for example, it’s likely a good idea to pay that debt off first before upping your 401(k) contribution. That’s because the average credit card interest rate is more than 20% 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.

Save money in a health savings account (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.

While you’ll have to have a health plan classified as “high deductible” to qualify for an HSA, those with room to spare in their take-home income could benefit significantly. For 2022, you can save up to $3,650 if your health plan covers one person, and up to $7,300 if your plan covers your family. Those 50 and older can also save an additional $1,000 per year in their HSA.

When it makes sense to max-out your 401(k)

There are situations in which maxing out your 401(k) might be a good idea. You may want to consider contributing to your upper limit if:

• You’re in a high income tax bracket and want to reduce your tax bill.
• You have extra cash each payday going into lower-yield savings.
• You want to take full advantage of compound interest and tax-deferred growth opportunities.

“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 $20,500 [in 2022], 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.” Keep in mind, however, that you may pay income tax on your 401(k) withdrawals during retirement if you didn’t opt for a Roth 401(k).

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 help you to retire on your own terms.

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.

“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 2022, 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. We even have a guide to help you max-out your Roth IRA each year.

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 powerful savings tools, they can have limited 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) and IRA, you could open a taxable brokerage account.

Inman says that, while a taxable investment account won’t provide any tax savings, it will give you, “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. 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. So, the answer to, “Should I max out my 401(k)?” is maybe. The answer ultimately depends on your financial situation and other financial goals. If you’re still struggling with this decision, find a financial advisor who can help review your current savings and help you plan for the retirement you envision.