Why You Should—and Should Not—Max Out Your 401(k) Contribution

Should you max out your 401(k)?

Image shows financial goals to meet before maxing out your 401(k).

The Balance / Nusha Ashjaee

Your employer may present you with benefit options when you're first hired. You may have to decide whether you'd like to take advantage of an employer-sponsored retirement plan. The 401(k) is the gold standard, with rules and limits set by the federal government.

Key Takeaways

  • Many people are advised to maximize the perks that come with 401(k) accounts, like tax-free contributions and employer-match programs.
  • If you are struggling financially, or have better retirement savings options, maxing out your 401(k) may not be in your best interest.
  • Certain financial goals are thought to be more foundational than maxing out your 401(k), like emergency funds, insurance, and more.

Contributing to Your 401(k)

You can contribute a portion of your earnings to a 401(k) account tax-free each pay period, subject to annual limits set by the Internal Revenue Service (IRS). Some employers even offer matching programs, where they contribute an equal amount to help grow your fund. It's clear to see how it makes sense to put in as much as possible and maximize your 401(k).

But there may be reasons to hold back. Your financial situation should play a role in how much you decide to put in an employer-sponsored retirement plan. So should the specifics of the plan. Consider whether your company's 401(k) is high in quality with solid growth rates and company matching. Make sure your own money base is solid, ensuring that you can afford to put some of your earnings away.

Maxing out your contributions probably isn't your best choice if you're struggling to pay bills each month, still working on other aspects of your finances, or if your 401(k) options aren't great.

There are many key financial goals to meet as you get older and plan for retirement. Think about paying off high-interest debt, building an emergency fund, and securing overall financial wellness.

When Should You Max Out Your 401(k)?

The most you can contribute to a 401(k) plan is $19,500 in 2021, increasing to $20,500 in 2022, or $26,000 in 2021 and $27,000 in 2022 if you're age 50 or older. You might want to do so if you can easily afford to max out your contribution based on the yearly limits without it causing a large impact on your budget.

Some personal finance experts suggest saving at least 15% of your annual income for retirement throughout your working career. Chances are that you could max out comfortably at the $20,500 limit if you're making at least $130,000 in 2022, and if you have a good handle on your current finances.

Think about when you might retire when you're planning for your retirement, how much you've saved, what your lifestyle might look like during retirement, and how much money you'll need each month to sustain that lifestyle. Once you have a rough target, work backward to figure out how much you should contribute to a retirement fund. What is your current budget like? Can you live comfortably if you contribute the max amount?

One other common best practice is to contribute at least the minimum required to capture your employer's 401(k) match if one is provided. You'll gain the full benefit of the match without losing a penny.

According to a study by the New School, 35% of all workers of age 55 through 64 have no retirement savings at all. This includes individual retirement accounts (IRAs), 401(k)s, and pension plans. Of the older workers surveyed who do have retirement savings, the median balance in their accounts was $92,000. That equates to about $300 per month to live on when they retire.

When Should You Avoid Maxing Out Your 401(k)?

Of course, not all people are in a position to add $20,500 a year to a retirement plan. If you earn $50,000 a year, that $20,500 represents 41% of your total income—some of which you may need to meet your living expenses. It’s okay that you may not have the excess cash flow needed to make this happen. Each year brings a new enrollment period, so you can always choose to increase your contribution over time if your financial situation improves.

There are other reasons to think about maxing out 401(k) contributions. Employer-sponsored plans come in many forms, but most are managed by outside investment firms with their own rate and package options. Your retirement plan at work may have a great track record with a history of steady growth, or it may be more modest. You may be able to have some say in whether your money is invested aggressively or cautiously, or you may have only one option.

It's possible that your plan charges high fees. You can usually find these details in your summary plan description and annual report. You should think about all these factors when you sign up and decide how much of your earnings will be put toward your plan each pay period.

Lastly, your 401(k) is only one of many potential retirement vehicles. You can always opt out of your company plan and save for retirement in an independent fund, like an IRA through your bank or credit union.

Other tax-advantaged retirement accounts, such as traditional or Roth IRAs, allow you to contribute up to $6,000 a year and give you more control over your options.

Financial Considerations Before Maxing Out Your 401(k)

Your 401(k) isn't the only thing that needs to be funded during your working years. There are a few key money goals that most experts agree you should focus on before you put all your excess cash in a 401(k). Ask yourself:

  • Do you have at least three to six months of basic living expenses set aside in an emergency fund?
  • Have you paid off any high-interest credit card debt, personal loans, car loans, or other debt?
  • Are you on track to reach any financial goals such as having a child, paying for a wedding, or buying a home? Is there some other major purchase or milestone that you are keen on making?
  • Do you have life insurance to provide for your loved ones?

Other Important Financial Goals to Consider

You should keep a few other things in mind as you decide how much to contribute to your 401(k) based on your own unique financial situation.

  • Do you have a formal estate plan with a will and other critical papers (such as living wills, health care power of attorney, trusts)?
  • Can you cover health care expenses? Make sure you're putting enough into your health savings account (HSA), both now and in the future, to cover medical expenses if you have a high-deductible health plan with an HSA combo.
  • Do you have proper disability insurance coverage to protect you and your family if you miss work for six months or more due to illness or injury?
  • Do you have long-term care plans in place if you're nearing retirement?

Frequently Asked Questions (FAQs)

Which should I max out first, my 401(k) or IRA?

You should prioritize maxing out your 401(k), at least until you've maximized any matching contributions your employer offers. You can turn your attention more aggressively toward IRA contributions after you've done that.

How much money will be taken out of each paycheck if I max out my 401(k) contributions?

The maximum annual contribution is $20,500 in 2022. That comes out to about $788 per paycheck in 2022 if you're paid every other week for a total of 26 paychecks in a year. Taxpayers over age 50 are granted an extra $6,500 catch-up contribution, for an annual limit of $27,000.

What percentage of workers max out their 401(k) contributions?

IRS data found that a little over 5.1 million Americans maxed out their retirement plan contributions in 2018. That's about 3% of the roughly 162 million workers by the end of that year.

Article Sources

  1. Internal Revenue Service. "2022 Limitations Adjusted as Provided in Section 415(d), Etc." Pages 1-2.

  2. Fidelity Investments. "How Much Should I Save for Retirement?"

  3. The New School, Schwartz Center for Economic Policy Analysis. "Policy Note: Inadequate Retirement Savings for Workers Nearing Retirement." Page 1.

  4. Internal Revenue Service. "Traditional and Roth IRAs."

  5. Internal Revenue Service. "IRS Announces 401(k) Limit Increases to $20,500."

  6. Internal Revenue Service. "Retirement Topics - Catch-Up Contributions."

  7. Internal Revenue Service. "SOI Tax Stats Individual Information Return Form W2 Statistics," Download "2008-2018 Form W-2 Tabulations," Select "Table 2.G."

  8. U.S. Bureau of Labor Statistics. "Tight Labor Market Continues in 2018 as the Unemployment Rate Falls to a 49-Year Low."