When should you, and when should you NOT max out your 401k plan?
401(k)s differ from IRAs in one significant way: 401(k)s allow current workers under 50 to put away up to $18,000 a year. For those over 50, a special “catch-up “provision will let them put in an additional $6,000, raising that threshold to $24,000.
These generous allowances prompt many retirement planners to push their clients into maxing out their 401(k) plans. However, there is more than a little disagreement between financial professionals about whether or not this is the best course of action.
If you’re lucky enough to have an employer who sponsors a 401(k) plan, then it is probably a good idea to sign up for the plan and contribute as much as possible, at least to the point where you get the employer’s matching contribution.
But should you try to hit the maximum allowable contribution?
If you’re like most people, you probably can’t afford to save that much money each year on a long-term basis. The vast majority of
Americans with 401(k) plans don’t even come close to maxing them out.
When Should You Try To Max Out Contributions to Your 401(k) Plan?
There are some financial goals that you need to focus on achieving before contributing the maximum to a 401(k) plan:
• You should have at least six months of basic living expenses set aside for emergencies.
• You should have enough life insurance and disability insurance in place.
• If you are close to retirement, you want to be sure you have planned your long-term care needs.
Money not spent rolls over year after year, and it’s yours to keep until you eventually need it. • If your employer has a high deductible health insurance plan that qualifies for an HSA, you might be better off maxing out your HSA before your 401(k). This is especially true if you have lower health costs and your employer contributes to your HSA account to offset deductibles; HSAs can be great deals. For example, you could use the money when you retire to help pay for your Medicare Part B premiums or other health costs. If you have a higher income, HSA currently gives you the ability to exclude up to $6,750 from taxes for family coverage. You can exclude another $1,000 if you are 55 or older. It is good to remember that an unexpected catastrophic health crisis can cause you to take loans on your 401(k) or even early withdrawals, which incur additional taxes and penalties. HSA’s can help ensure you have the money to handle these emergencies without having to drain your 401(k).
• You have met all or most of your non-retirement goals, such as buying a home, starting college funds, etc.
• You have paid off all your debts. In the long run, high-interest-rate debt will wipe out any gains you achieve by stuffing your 401(k) with cash. Pay your debt off first.
• If your 401(k) plan is not that great and has a lot of fees, you may be better off NOT maxing it out and putting the money into other vehicles.
Retirement planning, in many respects, is a kind of high-wire act involving saving enough money to last you later in life while also meeting daily and near-future needs. The good news, though, is that you don’t have to go it alone. You can and should engage the services of a professional who has the expertise to review all your retirement options, including 401(k)’s, private pensions, savings, and investments.
They will then be able to determine if maximizing your 401(k) makes sense in your particular situation or if you only want to contribute enough to meet your employer’s match,
