Should You Max Out Your 401(k)?

Should You Max Out Your 401(k)?

by Pinnacle Family Advisors

By Michael Vaughn, CFP®

If you’ve been actively planning for retirement, you’ve likely heard that maximizing your 401(k) contributions is touted as the ultimate goal. It’s a tax-efficient strategy to save for the future, and setting up automatic contributions effortlessly integrates this money into your financial portfolio. 

However, going all-in on maxing out your 401(k) contributions might not always be the wisest decision. Read the following insights to understand why.

You May Have Other Financial Priorities

While saving for retirement is important, it’s not the only financial goal you may have. For example, you may be saving for a down payment on a home, paying off debt, or building up an emergency fund. If you funnel all your extra money into your 401(k), these other areas of your finances may end up neglected. Make sure you have a well-rounded financial plan that addresses all your priorities. To start, consider the following to help you assess other potential goals:

  • Pay down any high-interest credit card debt.
  • Build up an emergency fund with 3-6 months’ worth of living expenses.
  • Make sure you have adequate health insurance.
  • Review your estate plan: do you have a basic will or trust in place to safeguard your loved ones in your absence?
  • Consider disability insurance in case an accident or injury prevents you from working for an extended period of time.
  • If you are married or have dependent children, consider obtaining adequate life insurance.

You May Have Access to Better Investment Options Elsewhere

Most 401(k) plans offer a limited selection of investment options, which may not be the best fit for your strategy. Suppose you have other investment accounts, such as an IRA or taxable brokerage account. In that case, you may have access to a wider variety of investment options. 

For example, let’s say your 401(k) plan only offers mutual funds but you’re interested in investing in individual stocks or exchange-traded funds (ETFs). In this case, an IRA or taxable brokerage account may be the better option. By diversifying your investments across multiple accounts, you can improve your returns and invest in the right mix of assets for your financial goals. 

You May Want More Flexibility in Accessing Your Money

Contributions to a traditional 401(k) are tax-deductible, but withdrawals in retirement are taxed as income. Withdrawals prior to age 59.5 are subject to tax and a 10% penalty if you don’t meet the strict criteria for a hardship withdrawal. If you’re planning to retire early or have other income streams in retirement, you may want more flexibility in accessing your money. Roth IRAs, for example, allow you to withdraw your contributions at any time without penalty, and qualified withdrawals of earnings are tax-free. Consider whether a Roth IRA or other investment vehicle might give you more flexibility both now and in retirement.

You May Pay Less in Fees With Other Investment Accounts

When considering whether to max out your 401(k) contributions, it’s also important to take into account the fees associated with these plans. Though 401(k) plans are convenient, they can also be expensive, with costs including administrative fees, investment fees, and expense ratios, among others. These fees can eat into your investment returns over time and can be especially costly if you’re not paying attention to them. Make sure you understand the fees associated with your 401(k) plan and consider whether there are lower-cost investment options available to you. It’s worth seeking the advice of a financial advisor to help you navigate these fees to help you get the most bang for your buck.

If You Do Max Out Your 401(k), Know Your Limits

If you choose to max out your 401(k), it’s important to know your contribution limits. For 2024, you can defer as much as $23,000 into your 401(k) (increased from $22,500 for 2023). 

One of the best parts of a 401(k) plan is that many employers offer matching contributions. The most common matching formula is 50% of employee contributions up to 6% of salary. This means your employer will contribute a maximum of 3% of your salary if you contribute 6%. Since employer matches are essentially free money and not considered income in the year received, it’s generally advised to contribute at least enough to get the maximum matching contribution, even if you don’t max out the full contribution amount.

Is Maximizing Your 401(k) the Right Move for You?

Although maximizing your 401(k) contributions can benefit certain people, it may not be the best move for everyone’s financial situation. At Pinnacle Family Advisors, we specialize in tailoring retirement savings strategies to fit your specific needs and goals. 

If you’re ready to explore your options, reach out to us to schedule your complimentary introductory meeting by emailing me at [email protected], calling (417) 351-2942, or using my online calendar.

About Michael

Michael Vaughn is a CERTIFIED FINANCIAL PLANNER™ professional and Vice President at Pinnacle Family Advisors (PFA) with 23 years of industry experience. Before joining the PFA family, he served clients with investment management and retirement planning at The Mutual Fund Store for 14 years. Michael graduated from Missouri State University with a bachelor’s degree in business administration and management and earned his CFP® certification in 2004. He also served 20 years in the Missouri National Guard, retiring in 2007 as a Major. He currently volunteers on the board of directors for Good Dads and Fellowship of Christian Athletes. Michael is married to Lori and they have two daughters. To learn more about Michael, connect with him on LinkedIn.