Maxing out your 401(k) might seem like a no-brainer until you read this.
Maxing out your 401(k) might be on your radar if you’re serious about beefing up your retirement savings. For 2024, that means socking away up to $23,000 if you’re under 50, or up to $30,500 if you’re 50 or older. About 15% of 401(k) plan participants accomplished this feat in 2023, according to the latest data from Vanguard.
But sinking that much into your workplace-retirement plan could mean giving up a big chunk of your paycheck every month. And that could be a huge mistake for some people.
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A few 401(k) pitfalls you probably haven’t considered
Let’s break down some of the downsides. First off, you’ll have to stick to the investment options in your employer’s plan, which usually don’t offer much variety. You’ll mostly see target date funds, mutual funds, and maybe some company stock. If you wanted to invest directly in individual blue chip stocks like Apple or Microsoft, you’re out of luck — unless you work for them. This could mean missing out on potential long-term gains by holding individual stocks.
On top of that, you’ll run up against some fees that could chip away at your returns. And if you’re like most people, you probably have little-to-no idea what your 401(k) fees actually look like. These fees can include investment-management fees, administrative fees, and individual-service fees. While they may not seem like a big deal at first, they can add up over time and impact your long-term investment growth.
Generally, you have to keep your 401(k) funds locked up until you reach age 59 1/2. This might not be ideal if an emergency arises and you don’t have much saved outside of the account. Sure, you could dip into your 401(k), but you’ll face a 10% penalty on top of paying taxes. For example, if you have $100,000 in your 401(k), a 10% penalty would immediately take $10,000 off the top, not to mention the taxes you’d still owe. All told, that’s a good chunk of change to give up for early access.
Don’t forget about other financial goals
It might be easy to dump all your money in a 401(k) and call it a day. Why so? Your employer does the heavy lifting by taking money directly from your paycheck before it hits your account, so you might not miss it, especially if you’re earning a solid income.
But before maxing out your 401(k), you might be better off spreading your paycheck across various accounts first, such as an emergency fund, an individual retirement account (IRA), and a brokerage account. This decreases the chances of you dipping into your 401(k) early. Also, investing in other assets outside of your 401(k) could offer more lucrative growth opportunities.
All in all, it’s a good idea to weigh the pros and cons of maxing out your 401(k) before doing it. There are plenty of appealing perks — many of which I’ve personally taken advantage of over the years. For one, the 401(k) contribution limits are much more generous compared to a traditional or Roth IRA, and if you’re lucky, your employer might offer an employer match to help you boost your savings. This could speed up your path to joining the 401(k) millionaire club, which is quite enticing. Plus, by lowering your taxable income through 401(k) contributions, you can also reduce your tax bill.
However, maxing out a 401(k) may not always be the best move for everyone. Take the time to review your financial situation and personal goals, as well as review the specifics of your 401(k) plan to determine the best strategy for maximizing your retirement savings.