Should I Max Out My 401(k)?

A pre-tax 401(k) is a retirement account offered by many American employers that allow employees to invest a portion of their paycheck in a variety of mutual funds or ETFs before income taxes are taken out.

As part of their personal finance strategy, many workers wonder if they should maximize their contributions to this tax-advantaged retirement account.

In this article, we’ll look at whether or not they should “max out” their 401(k) plan. Along the way, we’ll discuss the benefits and drawbacks of doing so, as well as the Internal Revenue Service (IRS) regulations on 401(k) contributions.

For more information on 401(k) plans and your options, you can reference the following articles Capitalize has published:

• 4 Options for Your Old 401(k)
• Find Your Old 401(k)
• Find All Your 401(k) Using Social Security Number

Benefits of Maxing Out a 401(k)

Maxing out your 401(k) contributions can help reduce your taxable income, which can, over time, result in significant tax savings.

Additionally, many employers offer matching contributions, meaning they will match a portion of your contributions up to a certain limit (known as a company match or employer match). This is essentially “free money” added to your retirement account, and taking advantage of employer contributions is highly recommended.

The potential long-term gains of investing in a 401(k) plan can be substantial, especially if you start early and make consistent annual contributions. For those aged 50 and over, catch-up contributions are available, allowing you to contribute even more to your retirement savings. If your employer happens to offer a Roth 401(k), you can make after-tax contributions, which can lead to tax-free distributions in retirement.

Learn more about 401(k) rollovers and employer contributions in our article Do You Have to Roll Over Your Entire 401(k)?

Drawbacks of Maxing Out a 401(k)

While maxing out your 401(k) can have many benefits, it may not be feasible for everyone due to relatively steep IRS contribution limits. On top of that, you can incur penalties and fees if you need to make early withdrawals from your 401(k) plan.

Also, any tax benefits associated with your 401(k) can be reduced or negated by high fees. So it’s essential to understand what you’re paying to invest in mutual funds through your employer — this includes any underlying investment expense ratios.

If you’re considering a Roth 401(k) or a traditional Individual Retirement Account (IRA), be sure to compare the benefits and drawbacks of each. Capitalize has published resources to help workers understand their options with these other types of retirement plans:

• 401(k) vs. IRA
• How to Roll Over Roth 401(k) to Roth IRA
• Roth IRA

Alternatives to Maxing Out a 401(k)

There are other investment options available besides maxing out your 401(k), such as contributing to a traditional IRA, a Roth IRA, or a taxable brokerage account. Diversifying your investments by including real estate, Health Savings Accounts (HSAs), and other assets can help create a more balanced retirement portfolio.

It’s important to create a personalized retirement savings plan that fits your unique financial situation, taking into account factors such as your income, living expenses, and financial goals.

For instance, using after-tax dollars to fund a Health Savings Account (HSA) can be a tax-efficient strategy because HSAs offer triple tax benefits: tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses.

Investing in a traditional IRA can also provide an immediate tax break because, in many cases, contributions are tax-deductible. Note that not all traditional IRA contributions will be deductible; this usually happens if you have a retirement plan at work or if you earn too much.

Capitalize has helped a number of customers consider their investment options outside of maxing out their 401(k). If you’re wondering what yours are, check out these articles:

• How to Cash Out 401(k)
• 401(k) Rollover vs. Withdrawal

So, Should You Max Out?

Before deciding to max out your 401(k), it’s important to analyze your unique financial situation, taking into account factors such as emergency fund savings, credit card debt, and living expenses.

Compare the tax benefits of a 401(k) plan to the fees and other costs associated with it, and consider future tax rates and inflation when making your decision. It’s also important to factor in any employer contributions (remember: “free money”) added to your investment account.

For more information on analyzing your decision, check out these Capitalize articles:

• 401(k) Rollover to Roth IRA
• How to Rollover 401(k)

401(k) FAQs

Is it a good idea to max out 401(k)?

Maxing out your 401(k) can be a good idea for some people, but it depends on your unique financial situation, goals, and the availability of employer contributions. Be sure to weigh the benefits and drawbacks of maxing out your 401(k) before making a decision.

What percentage of your income should you contribute to your 401(k)?

The percentage of your income to allocate towards maxing out your 401(k) depends on your financial situation, goals, and other factors. A common rule of thumb is to save at least 10–15% of your income for retirement, but this may vary based on individual circumstances.

What is the maximum contribution limit for 401(k)?

The maximum contribution limit for 401(k) plans can change annually; in 2023, the maximum employee contribution is $22,500 if you’re under 50, and $30,000 if you’re 50 or older.

For the most up-to-date information, consult the IRS website.

Is it better to max out a 401(k) or Roth IRA?

The decision to max out a 401(k) or Roth IRA depends on your unique financial situation, goals, and tax circumstances. Consider factors such as tax benefits, fees, and income limits when making your decision.

You might also consider contributing to both accounts for maximum tax diversification.

In Summary

Maxing out your 401(k) can offer substantial benefits, such as tax-deferred savings, employer contributions, and long-term investment growth. However, there are also drawbacks and alternatives to consider, such as fees, contribution limits, and other investment options like IRAs and HSAs. Ultimately, the decision to max out your 401(k) should be based on your unique financial situation and goals.

Take the time to evaluate your options and create a personalized retirement savings plan. Seeking guidance from a financial advisor or a financial planning expert can help you navigate this process and choose the best option for your needs.

If consolidating your retirement accounts is right for you, Capitalize is a trusted partner that can make the entire rollover process a snap. Get in touch with our team today.