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).

Nusha Ashjaee / The Balance

If you have a solid financial foundation in place and your employer-sponsored retirement plan is high in quality, maxing out your annual contributions makes sense. If you're 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.

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 financial wellness as you age.

When You Should Max Out

In 2020 and 2021, the maximum amount you can contribute to a 401(k) plan is $19,500 ($26,000 for those age 50 or older). If you can afford to max out your contribution, you might want to do so.

Some personal finance experts suggest saving at least 15% of your annual income for retirement throughout your working career. If you're making at least $130,000 in 2021, that means that you could likely max out comfortably at the $19,500 contribution.

Another best practice is to contribute at least the minimum required to capture your employer's 401(k) match, if one is provided.

According to a study by the New School's Schwartz Center for Economic Policy Analysis, 35% 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.

When You Shouldn't Max Out

Of course, not everyone is in a position to contribute $19,500 a year to a retirement plan. For example, if you earn $50,000 a year, then that's 39% of your total income—some of which you may need to live on. 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. You can usually find this information in your summary plan description and annual report.

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).

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.

Financial Considerations Before Maxing Out

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 should try to reach 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.

Other Important Financial Goals to Consider

Depending on your unique financial situation, you may have additional financial goals to consider as decide how much to contribute to your 401(k):

  • You have a formal estate plan, including wills and other critical documents (living wills, health care power of attorney, trusts, etc.).
  • You're contributing up to the maximum amount possible to your Health Savings Account (if you're 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're nearing retirement, you have long-term care plans in place.

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