Did you know you can only contribute a certain amount to a 401k per year? The biggest benefit of maxing out your 401k is the chance to save more money for retirement. If you are already making some contributions, you might start to wonder: should I max out my 401k? Well, keep reading.

The 2023 limit for a 401k is $22,500 for people under 50, and contributing the full amount is known as “maxing out” your 401k, which might be a good choice for you. But how do you know for sure?

As with most things, the answer depends. Those who are financially stable, have good monthly cash flow, and have access to a 401k with low fees might want to consider maxing their account.

However, locking money up in a 401k generally means you can’t access your savings (without penalties) until you’re near retirement age.

Knowing the pros and cons of maxing out your 401k can help you make an informed decision on whether or not it’s time to up your 401k contributions. Let’s dive in and look at why you would — or wouldn’t — want to max out a 401k.

Should I max out my 401k? 4 Reasons you should

A 401k is one of the most common types of employer-sponsored retirement plans.

Deciding to max out a 401k is a personal decision, but there are reasons you might want to consider it. Maxing out your 401k could be a smart financial choice if:

• Your plan has low fees and plenty of investment options
• You’re looking to lower your taxable income for the year
• You want to get rid of the temptation of using retirement savings early

Let’s take a closer look at why you might want to max out your 401k.

1. Your 401k plan has low fees and great investment options

Your 401k probably has a handful of fees attached to it. In general, 401k fees consist of administration fees and investment fees.

The plan’s service provider charges administration fees to help cover the cost of hosting and managing the plan itself. This might include expenses like record keeping, accounting, and legal services. Investment fees, on the other hand, cover the cost of managing investments and investment-related services.

If you happen to be on a 401k plan with low plan fees, you might want to take advantage of it. With lower fees, you’ll get more out of your money by investing in the plan.

In turn, the more you invest in the plan, the more money you can build for retirement.

For example, you’re trying to decide whether you should max out your 401k or put that money into an individual retirement account (IRA) and other brokerage account. The fees on your 401k average out to 1% of your total balance per year, but the fees for the other accounts are around 3% per year.

In this case, it makes more sense to put your money in the account with lower fees.

2. You can lower your taxable income

One of the biggest benefits of a traditional 401k is the ability to lower your taxable income for the year. When you contribute to a traditional 401k, the money is generally taken from your paycheck and automatically added to your 401k account.

This process happens before your employer calculates taxes on your earnings. Thus, you don’t pay taxes on your traditional contributions.

When tax time rolls around, your year-end earnings statement doesn’t show those contributions as part of your taxable income. The lower your taxable income, the more likely you’ll lower your tax liability.

Let’s say you make $100,000 per year and usually pay taxes on the full amount. Maxing out your 401k would reduce about 20% of your annual taxable income, which could help lower how much you owe in taxes.

If you’re looking for an easy way to significantly reduce your taxable income, maxing out your 401k could be a great tax strategy.

Be sure to talk with your tax advisor about your specific situation to make sure maxing out your 401k for tax benefits makes the most sense for your financial situation, as well as to understand the difference between a Roth vs traditional 401k.

3. You can lock in your retirement savings

Except in certain situations, you can’t withdraw money from your 401k without a penalty fine before age 59 ½. When you contribute money to your 401k, you’re essentially locking it up in the account until you retire.

Making it harder to access your money, however, can be a big benefit if you’re still learning how to build discipline with finances. The money in your 401k can grow without giving you the temptation to withdraw funds early. Maxing out your 401k further helps you build these hard-to-access retirement savings.

4. You’ll be able to take advantage of any 401k match

Employer 401k matching is a contribution to your retirement plan made by your employer. A 401k match means your employer will put money into your retirement account based on what you’re contributing on your own. Usually, a 401k is a percentage match up to a certain percentage of your salary and it is essentially free money!

For instance, your employer might offer a 50% 401k contribution match up to 5% of your annual income. If you make $100,000 and contribute $5,000 to your 401k, your employer will contribute an additional $2,500. If you only contribute 4%, or $4,000, to your 401k, your employer would only match $2,000.

Keep in mind that, maximizing your employer match isn’t the same as maxing out your 401k. Maximizing employer contributions means contributing the full percentage of your employer’s match offer.

For example, if your employer offers to match up to 6% of your salary, you could maximize this benefit by contributing the full 6%.

Expert tip

When you’re wondering, “Should I max out my 401k?” this means contributing the full amount allowed by the IRS. Maxing out a 401k might not be financially feasible for everyone, but you can still reap the benefits by taking advantage of your employer match if you have access to one.

After all, you’re essentially getting free, tax-deferred money. Even if you can’t afford to fully max your 401k to the IRS limits, setting a goal to get the full amount of your employer match is a smart financial move.

Questions to help you determine if you should max out your 401k

Maxing out your 401k can be one of the smart tips for retirement planning. The more you save over the years, the more financial freedom you give yourself in retirement.

In addition, having a larger balance in your 401k makes it easier to build wealth through things like interest earnings.

On the other hand, contributing over $20,000 of your annual salary to a retirement account might not be possible. Asking yourself key questions can help you make an informed choice on whether it’s a good idea to max out your 401k. Some questions include:

• Do you make enough money to contribute the full amount?
• Have you paid off high-interest or high-risk debt, such as credit cards or personal loans?
• Do you have significant non-retirement savings, such as an emergency fund?
• Does your 401k have reasonable investment fees?
• Does your 401k plan have multiple investment options for your level of risk and estimated retirement year?
• Are you looking for ways to lower your taxable income this year?
• Do you not trust your financial discipline and want to put your retirement savings where they’re not easily accessed?

If you answer “yes” to most or all of these questions, maxing out your 401k could be a good retirement planning strategy for you.

On the other hand, if you answer “no” to most of the questions, you may want to focus on other financial tasks first, such as getting out of high-interest debt or building an emergency fund.

Note: Even if you cannot max out your retirement savings, you can still contribute to it. For example, based on your answers to the questions, you may determine you can only contribute 5% or 10% right now and that’s ok!

What to do before maxing out your 401k

There are a few things to consider before maxing out your 401k. By checking off the items in this list first, you’ll set yourself up for financial success when you max out your retirement plan.

Pay off high-interest or high-risk debt

Carrying debt and trying to max out your 401k account can quickly throw off your long-term financial goal setting. By trying to both max your retirement savings and pay the minimum on your debt, you’re splitting your finances. This can lead to not being able to pay off more than the minimum on your debt.

If you have debt with high interest, such as credit card debt, you might not be able to keep up with your debt payments or reduce credit card debt. When you can’t pay off more than the minimum on your debt, the interest charges keep adding up. You might have to carry that debt — and interest — into retirement, negating the benefit of maxing out your 401k over the years.

Focusing instead on paying off debt before retiring lets you take care of one of the biggest drains on your finances, your debt. And once you’re out of debt, you’ll have more disposable money to put toward your 401k contributions.

For example, you might decide to contribute just enough to your 401k to get your employer’s match while you focus on paying off debt. If no match exists, you might instead decide to contribute 1% to 5% to take advantage of some tax deferred savings while you focus on your debt repayment.

Build an emergency fund

Having access to emergency cash is one of the most important financial tools you can give yourself. Emergency funds are liquid cash accounts that give you fast access to your money when you need it most.

For example, your car breaks down, and you need several thousand dollars in repairs. Or, you suddenly lose your job and need to cover rent, utilities, and other necessary expenses until you find another job.

Ideally, you’d carry around 3 to 6 months’ worth of living expenses in your emergency fund before putting too much money into other savings, including trying to max out your 401k. You can — and should! —still try to contribute to your retirement fund, but the bulk of your savings should first go toward emergency savings.

You may also want to build some non-retirement savings before maxing out a 401k. As the money in a 401k is basically inaccessible without a penalty, having funds in a non-retirement account can help you cover large purchases or expenses until retirement.

Additionally, non-retirement savings, such as a high-yield savings account or brokerage account, gives you the flexibility to access cash both before and in retirement.

Consider your cash flow

Cash flow is how much money moves into and out of your bank account each month. The goal is to have a positive cash flow — meaning more money is coming into your account than going out.

When it comes to retirement planning, cash flow plays an important role in how much you can save. Even two people with the same income could have vastly different cash flows based on their monthly expenses.

For instance, say two women both make $5,000 per month.

The first woman has only $3,000 in expenses, leaving her with $2,000 to put towards savings and retirement. The second woman needs $4,500 to cover her monthly expenses and has $500 to put toward savings.

The first woman has a larger cash flow and will likely find it easier to max out a 401k than the second.

Should I max out my 401k based on my income and cash flow?

Your income and cash flow can be good indicators of whether it’s a good idea to max out your 401k.

Let’s say one woman has an annual income of $40,000. She isn’t carrying debt and keeps her expenses low at around $15,000 per year.

However, maxing out her 401k would require her to contribute over half of her salary to her retirement account. Even living on a bare bones budget, it would be difficult for this woman to put around $20,000 into a single retirement account.

A different woman, however, makes a six-figure salary of $150,000 and spends $100,000 per year on expenses. After maxing out her 401k and paying expenses, this woman still has around $30,000 to put toward other savings.

While the second woman has significantly more expenses than the first, her income and cash flow make maxing out her 401k possible.

Like the women in the example above, you can use your income and cash flow to decide if you should max out your 401k. The lower your income, the less likely it’ll be in your budget to max out your 401k (but you can still contribute something to it).

If you have a higher income, you’ll also need to consider your monthly expenses to determine if you have enough cash to max out your retirement plan. To do this, you can list your monthly income and expenses to see how much money you have to put into savings each month.

Ideally, you’ll have enough money left over to invest both in non-retirement accounts and your 401k rather than just investing all of it to max out your 401k.

What is the downside of maxing out a 401k?

There are a few downsides to maxing out your 401k, such as:

• Tying up your cash savings
• Potentially high plan fees
• Loss of match funds if you start wondering, “Should I quit my job?” and then you decide to do so

Less access to cash

The most obvious downside to maxing out your 401k is losing easy access to your money. Money in retirement savings is often non-liquid, meaning you can’t withdraw it with ease.

In addition, you may have to pay penalties on the money you take out.

Unless you have ample non-retirement savings, maxing out your 401k could lead to cash flow issues. These issues could be minor, such as not being able to save money as quickly as you wanted for a down payment on a new car. Or these cash flow issues could put you in a serious situation, such as not having the money to pay your mortgage or rent.

Potential for high fees

Not all 401k plans are created equal, and some plans have high fees that can eat into your savings. If your plan has a large administrative fee or charges fees on many different aspects of your investments, such as placing an investment order, you may want to focus on other retirement saving accounts.

Additionally, your 401k plan is overall managed by your employer and the plan administrator, giving you less control over your investment and savings. You’ll generally get more investment options, lower fees, and more control over your money with other types of accounts, such as an IRA or other self-directed account.

Could lose match benefits if not vested

Employer contributions to your 401k don’t automatically belong to you.

Generally, employees must stay at the company for a certain amount of time before vesting in their accounts. In retirement terms, “vesting” refers to the ownership of the money in the account.

Any money you contribute to your account on your own is always 100% vested from the start, meaning you own this money.

However, your employer match funds may not be yours — at least not at first.

Most 401k plans have a vesting schedule. The longer you stay at the company, the more of this money you own or become vested in. If you quit your job before being fully vested, you’ll forfeit any unvested money.

Say you vest 20% each year you’re with a company. Your vesting schedule would look like this:

• 1 Year: 20%
• 2 Years: 40%
• 3 Years: 60%
• 4 Years: 80%
• 5 Years: 100%

After five years of service, you’re fully vested. If you leave the company, you’ll take all of your employer contributions with you.

However, if you quit after only three years, you’ll only own 60% of employer contributions to your account.

As you consider whether or not to max out your 401k or employer match, think about whether you plan to stay with the company. If you plan to leave before being vested in your account, you may want to focus on other ways to build retirement savings.

At what age should I start maxing out my 401k?

Your age is only one small factor in when to start maxing out your 401k. Your income and expenses, current savings, and debt play a much larger role in whether maxing out your 401k is a good idea.

For example, one person makes $100,000 annually but has no debt and over a year’s worth of non-retirement savings. Their coworker makes $200,000 but spends over half of their income on high-interest debt payments and has no emergency fund.

Despite making less money, the first person may be in a better position to max out their 401k. Their ages may not play much of a role in the decision.

The exception to this is employees over age 50. At age 50, the IRS lets you make “catch-up” contributions to retirement accounts. If it works for your financial situation, maxing out your 401k with the general limit and catch-up contribution limit could boost your retirement savings significantly just before you retire.

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Decide if you should max out your 401k to increase your retirement savings!

Now you know the answer to, “Should I max out my 401k?” Saving for retirement is a great step to securing your financial future.

Before maxing out your 401k, however, it’s a good idea to consider your current financial obligations. You may want to start with financial wellness tips like creating a debt reduction strategy and building emergency savings, then you can plan to save for retirement and max out your 401k.