January 11, 2022
If you are lucky enough to work at a company that offers a 401(k), then you probably know that a certain amount of your income can be deferred pre-tax into a retirement account. While this is an awesome benefit, there are limits set by the IRS on what you can contribute. That limit changes annually but for 2022 is set at $20,500 with certain additional catch-up contributions allowed if you are over 50.
Traditional financial planning wisdom urges people to both save aggressively for retirement and also fully utilize all tax-advantaged accounts. But, even if you can max out your annual 401(k) contribution, should you?
In most cases: yes - max out that 401(k)!
Considering that almost half of Americans are not financially prepared for retirement, consciously saving more is a good thing, especially if that money is being put into a tax-advantaged account. 401(k)’s, particularly employer-matched plans, are an awesome resource to be able to tap into post-retirement. And while below we outline instances where you might not want to max out your 401 (k), in virtually every situation, you should contribute at least as much as your company will match.
There are sometimes compelling reasons not to max out your 401(k) - from needing to meet short-term needs to strategic long-term financial planning decisions. So what are some reasons why you shouldn’t max out your 401(k)?
If you have high-interest debt
Don’t squirrel away all of your money into retirement accounts if you have high-interest debt. You should always, always pay off high-interest debt, like credit card debt, before making any other money moves. After all, there is absolutely no investment opportunity that can guarantee you a 16% return - the average interest rate charged on credit card debt. If you don’t pay off your high interest debt, you may find yourself on the debt treadmill and have a hard time making forward progress towards achieving your financial goals.
If you have critical, short-term cash flow needs
There are times when your short-term cash needs supersede your ability to save. Unexpected expenses have a way of popping up at the most inopportune times. It’s best to have an emergency fund to cover these types of expenses in case, say, your furnace flames out. But if you don’t have an emergency fund, it is unwise to put money into your retirement accounts if it means you are going to miss your mortgage payments - or even put yourself at risk of missing your mortgage payments. This might mean not maxing out your 401(k), or it might mean not saving at all until you can get your personal finances better organized.
If you have short-term goals that require cash
While you need to strategically plan for your long-term goals, don’t forget about your short-term goals, too! While it’s always smart to be saving for the future, the benefit of a long-term goal is that you don’t have to hit it right away. For example, if you would like to buy a house, then maybe you are not maxing out your 401(k) while you save the money for a down payment. There are ways to borrow from your 401(k) penalty free, one exception being to buy a house, but make sure to do your research as the requirements can be strict.
If you are going to retire early
Other than for limited exceptions, you aren’t able to withdraw funds from your 401(k) penalty free until you are 59.5 years old. So, if you are planning to retire early, say, at 55 years old, you need to consider if you have enough savings to cover those 4.5 years you will go without income. If you are lucky enough to be eligible for early retirement or, worst case scenario, if you are forced into early retirement, then you need money in brokerage accounts that you can utilize penalty-free.
But, please, don’t miss the forest for the tree - unless you meet one of the requirements above, go ahead and do what you can to hit the limit on contributions for your 401(k). And, if there’s money left over, put it into your brokerage account - your future self will thank you!
Fortunately uses data to help people achieve their financial goals - providing simple answers to complex questions. Add your short-term and long-term goals into our tool to find out how much and when to contribute to your 401(k).
January 11, 2022