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

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When it comes to saving for retirement, a general guideline is to save, save, and save some more. And many Americans aren't doing that.

According to a study by the New School's Schwartz Center for Economic Policy Analysis, 35 percent of all workers ages 55 to 64 have no retirement savings in either a defined-contribution plan, such as an individual retirement account or 401(k) plan, or a defined-benefit pension plan. And the median balance in a defined-contribution account for the older workers who have one is $92,000. That's enough for only $300 in monthly income in retirement.

Given that rather bleak picture, making the maximum contributions to your 401(k) or similar retirement plan might seem like a no-brainer.

Key Percentages

Most personal finance experts suggest saving 10 to 20 percent of your annual income throughout your working career. The goal is to have saved enough retirement money so that each year, you'll have at your disposal 70 percent to 80 percent of the income you earned annually prior to retirement.

Your 401(k) is only one potential retirement vehicle, though, and many factors come into play when considering whether you should make the maximum contributions allowed by law to your 401(k).

When You Should Max Out

A best practice suggestion is to at least save enough to capture your employer's 401(k) match, if one is provided. (Some employers will contribute a percentage, up to 100 percent, of the amount an employee puts into a 401(k) plan.)

And reaching those annual savings and retirement income goals most likely means going beyond the company match. In 2019, the maximum amount you can contribute to a 401(k) plan is $19,000 ($25,000 for those age 50 or older). If you can afford to max out your contribution, you might want to do so.

Financial Considerations Before Maxing Out

However, your 401(k) plan isn't the only thing that needs to be funded during your working years. There are some important financial goals you ought to have reached before you begin contributing the maximum amount to your 401(k):

  • You have at least three to six months of basic living expenses set aside in an emergency fund.
  • You have eliminated high-interest credit card debt, personal loans, car loans, etc.
  • You are on track to reach shorter-term financial life goals such as having a child, buying a home, or another major purchase.
  • You have adequate life insurance coverage.
  • You have a formal estate plan including wills and other critical documents (living wills, health care power of attorney, trusts, etc.).
  • You are contributing up to the maximum amount possible to your Health Savings Account (if you are covered by a high-deductible health plan).
  • You have adequate disability insurance coverage to protect you and your family if you miss work for six months or more.
  • If you are nearing retirement, you have long-term care plans in place (LTC insurance, self-pay, etc.).

When You Shouldn't Max Out

Of course, not everyone is in a position to contribute $19,000 a year to a retirement plan. If you earn $50,000 a year, that's 38 percent of your total income. It’s okay to acknowledge you may not have the excess cash flow needed to make this happen.

There are other reasons to reconsider maxing out 401(k) contributions. If your retirement plan at work is burdened by high fees and expenses or has a lackluster investment lineup, it may not be worth going above and beyond the maximum contribution for which you can get the company match.

Other tax-advantaged retirement accounts, such as traditional or Roth IRAs, allow you to contribute up to $6,000 a year ($7,000 for those age 50 or older) and give you more control over your investment options.

The Bottom Line

If you have a solid financial foundation in place and your employer-sponsored retirement plan is high in quality, maxing out your contributions makes sense. If you are still working on other aspects of your financial life plan or your 401(k) options aren't great, maxing out your contributions probably isn't your best choice.

The good news for those in the latter camp is that paying off high-interest debt, building up your emergency safety net, and focusing on other financial goals are also important steps on the path to true financial wellness.

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