Should I Max Out my 401k? (Transcript)
Should I max out my 401k? The short answer is always typically yes, but the longer answer may be, maybe not depending on individual situation. For employees that have access to retirement contribution plans like a 401k or a 403b: you should really take a hard look at contributing to them.
There are numerous benefits. For employees you can contribute up to $18,000 of your own pay into one of these plans. And if you are over 50, you could add another $6,000 on top of that. That’s a total of $24,000 of savings tax deferred. Now there are a lot of benefits to doing this and I want to get into a few of those benefits, but then I want to give you the other side and help you to understand why it might not necessarily make sense to contribute the most that you can to your 401k.
Three Benefits to Maxing Out Your 401k Contributions
There are three main benefits I see as to why maxing out your 401k makes a lot of sense. First obviously is the tax savings. Depending on your income tax bracket and the state that you live in, each dollar that you can contribute to you 401k 30 to 40, maybe even 50 cents on the dollar of tax savings. That’s huge!
Second, it allows you to take advantage of matching contributions from your employer. Let’s say you make $200,000 salary and your employer matches 50% of every $1 you contribute into the plan up to 6% of your salary. On an annual basis that’s an extra $6,000 in your pocket if your maxing out the contributions to hit that match percentage. Over ten years, that’s $60,000. Huge amounts of money!
And finally, the fuzzier reason why I like contributing to a 401k is it is a tax efficient and automatic way to save for a lifestyle change later on. Whether thats retirement, working part time once you hit a certain age — this really enables you to do that and its a way to automate that savings and meet those goals while at the same time minimizing your tax.
Should I Max Out my 401k? Don’t forget about this!
So the benefits are clear, but let’s get to why it might not necessarily make sense to max out your 401k. There’s one huge drawback to contributing money into a 401k and that is that the money is largely untouchable until you are 59 1/2. There are certain exceptions, but before that age if you try to pull money out of the 401k to access it to purchase a home or for whatever else, you are not only going to incur regular income taxes on those distributions, but you’re also going to incur penalties. So it makes it very tax prohibitive to ever access that money. As a result, you should think of the money in the 401k or 403b as largely illiquid to you.
And as a result herein lies the rub with answering the question “Should I max out my 401k?” And that is, do contributions to your 401k compete with other goals you have. Do you have enough in emergency savings? Are you thinking about purchasing a home and you’re saving for a down payment? Or are you moving into a new home and do you need a certain amount of money each month to meet your mortgage payments, taxes and all the other expenses that you incur. Obviously you have to weigh these two. That’s why answering this question is not so simple. It really depends on your life circumstances and your life goals and aspirations and how contributing to a 401k fits into those goals.
Thanks and as always if you have any questions, please feel free to reach out.
For additional reading: see articles here and here.
Jim is a financial advisor and owner of Thinking Big Financial, Inc. Thinking Big Financial is a fee-only registered investment advisor offering financial planning and investment management services. Specializing in working with the LGBTQ Community.
Please read my legal disclaimer here.