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

When you are first hired and just starting at a new job, your employer may present you with benefit options. You'll have to decide whether you'd like to take advantage of the employer-sponsored retirement plan. The 401(k) is the gold standard, with rules and limits set by the federal government.

You can elect to contribute a portion of your earnings to this account each pay period tax-free, subject to the annual limits set by the IRS. Some employers even offer matching programs, where they contribute an equal amount to help grow your fund. I'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 own 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 the following:

  • If your company's 401(k) is high in quality (with solid growth rates and company matching)
  • If your own money base is solid, ensuring you can afford to put some of your earnings away)

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, maxing out your contributions probably isn't your best choice.

We'll walk you through a few factors to help you decide whether to max out—or not to max out—your 401(k).

As you get older, there are many key financial goals to meet as you 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)?

In 2020 and 2021, the most you can contribute to a 401(k) plan is $19,500 each year (or $26,000 for those age 50 or older). If you can easily afford to max out your contribution based on the yearly limits, without it causing a large impact to your budget, you might want to do so.

Some personal finance experts suggest saving at least 15% of your annual income for retirement in your working career. If you're making at least $130,000 in 2021, and if you have a good handle on your current finances, chances are you could likely max out comfortably at the $19,500 limit.

This advice is general, so when planning for your own retirement, think about when you might retire, how much you have saved, what your lifestyle might look like during retirement, and how much 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. That way, you're gaining the full benefit of the match without losing a penny.

According to a study by the New School, 35% of all workers 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, once they retire.

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

Of course, not all people are in a position to add $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 that you may not have the excess cash flow needed to make this happen. Each year brings a new enrollment period, so over time if your financial situation improves, you can always choose to increase your contribution.

There are other reasons to think about maxing out 401(k) contributions. Employer-sponsored plans come in many forms. Most, though, 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 past 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 each pay period will be put toward your plan.

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 ($7,000 for those age 50 or older) and give you more control over your options.

Financial Considerations Before Maxing Out Your 401(k)

Your 401(k) is not 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

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

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

Frequently Asked Questions (FAQs)

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

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

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

The maximum annual contribution for 2021 is $19,500. If you're paid every other week (for a total of 26 paychecks per year) that comes out to $750 per paycheck.

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

The latest IRS data available 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 that year.