If you want to optimize your retirement, maxing out your 401(k) may be a goal you set every year. And it's an admirable one: It ensures that you're putting away a solid chunk of your income into a retirement savings account where it can grow over time. But is it always a good idea?
Here's what you should know.
It minimizes your taxable income now
One of the key benefits to maxing out your 401(k) is that it means you'll be reducing your taxable income by putting it into your retirement brokerage account, thus reducing your tax liability. Of course, as with any retirement account, that's because there is a trade-off: You'll have to pay taxes on that amount when you withdraw it in retirement. So, assuming you earn more in retirement, that would be a higher percentage of your money going to taxes -- and vice versa.
There can be consequences for taking out that money early
Now let's look at the flipside of the maxing-out-your-401(k) argument: What happens if you run into trouble and need that money you already stashed away in your 401(k)? These accounts were designed to hold your money for decades and support you after your working life has ended, so there are consequences for taking early withdrawals.
For a 401(k), that means withdrawals taken before age 59 1/2 would incur a 10% tax, on top of regular income taxes. A $10,000 early withdrawal, for example, could cost you $1,000 before income taxes.
Four tips for successfully navigating the retirement savings question
Saving for retirement is important, but so is ensuring that you're keeping up with your various expenses as a working person. To find that balance, make the following moves.
1. Figure out your ideal monthly budget
If you don't have a working budget, now is the perfect time to make one. And remember that these are meant to be flexible, changing as you need them. So it's best to regularly revisit your various spending habits to make sure they're still serving you. But as a start, creating a budget will help you understand how much you can safely stash in a retirement account each month.
2. Make sure you're accounting for emergency savings
It may be tempting to skip on the emergency fund contributions, especially if you're new to the working world or you're on a tight budget. But it's the best defense against having to take money out of your retirement accounts if you get an expensive unplanned bill. Aim to save three to six months' worth of necessary expenses, like rent, utilities, and food.
3. Set aside some of your retirement savings in a high-yield savings account
This may sound counterintuitive if you're looking for the maximum contribution, but for those who may be worried about the consequences of pulling money out of a retirement account in a pinch, a savings account can be a useful option. This way, that money could sit in an accessible account during the year, and then at the end, you could decide to add it to an IRA and still get the tax benefits.
4. Talk to a financial advisor
If you aren't sure where to start for handling the question of how much to save for retirement, a financial professional can help guide you. They might also be a good resource for creating a budget that also helps you pad your emergency fund.
Maxing out your 401(k) can absolutely be a solid way to invest your money. But for those who aren't on the most solid financial ground yet, or who simply have many other goals on their plate, there may be other methods that can still lead to a secure retirement.
FAQs
It minimizes your taxable income now
What happens after I max out my 401k? ›
Next Steps
The first place we recommend investing after you've maxed out your 401(k) is an IRA. Learn more about opening a Roth IRA and reach out to a SmartVestor Pro to get started. If you aren't taking advantage of your workplace's HSA, set up a meeting with your HR representative and discuss your options.
What happens when you reach the maximum 401k contribution? ›
What Happens If You Go Over the 401(k) Contribution Limit? If you exceed the 401(k) contribution limit, you will have to pay a 10% penalty for early withdrawal, as you must remove the funds.
Is maxing out a 401k a good idea? ›
If the fees in your employer-sponsored plan aren't high and you're offered a variety of investment options, it may be worthwhile to max out your contribution. If the fees are high, you could consider directing money toward a traditional or Roth IRA first.
Will my 401k automatically stop at limit? ›
Contributions to a 401(k) plan are capped annually by the IRS, with limits for 2024 set at $23,000 (and an additional catch-up contribution of $7,500 for those over age 50). Typically, once you reach this limit, your payroll system will automatically halt additional contributions so that you don't exceed the limit.
At what income level should you max out your 401k? ›
You're a High-Income Earner
So if you're 100% debt free and have an annual salary of $150,000 or more, you could max out your 401(k) simply by investing your entire 15% through your workplace retirement plan.
Where to put your money after maxing out your 401k? ›
Your first step is likely a traditional or Roth IRA. Next, look at various strategic investments, which vary in risk, from bonds to variable annuities. Also consider alternative options, such as real estate, HSAs, and investing in a business.
What happens if you don't remove excess 401k contributions? ›
Treatment of excess deferrals
Unless timely distributed, excess deferrals are (1) included in a participant's taxable income for the year contributed, and (2) taxed a second time when the deferrals are ultimately distributed from the plan.
Can I contribute 100% of my salary to my 401k? ›
Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit: $23,000 in 2024 ($22,500 in 2023; $20,500 in 2022; $19,500 in 2020 and 2021), or $30,000 in 2023 ($27,000 in 2022; $26,000 in 2020 and 2021) if age 50 or over; plus.
Can I put all of my bonuses in my 401(k) to avoid taxes? ›
Your bonus will be taxed, but you can lower the amount of your taxable income by depositing some or all of it in a tax-deferred retirement account such as a 401(k) or IRA. However, this does not mean you will avoid paying taxes completely.
What Happens to My 401(k) If the Stock Market Crashes? If you are invested in stocks, those holdings will likely see their value fall. But if you have several years until you need your retirement account money, keep contributing, as you may be able to buy many stocks on sale.
Do you lose company match if you max out your 401k? ›
If you max out your 401(k) early in the year, you could miss part of your employer match, experts say. But some 401(k) plans offer a “true-up,” or additional deposit of the remaining employer match if you max out contributions before year-end.
Is a 401k worth it anymore? ›
The value of 401(k) plans is based on the concept of dollar-cost averaging, but that's not always a reliable theory. Many 401(k) plans are expensive because of high administrative and record-keeping costs. Nonetheless, 401(k) plans are ultimately worth it for most people, depending on your retirement goals.
What happens when I hit my max 401k contribution limit? ›
Your tax bill will rise (or your refund will shrink) relative to the amount of the excess 401(k) contribution. Handle excess earnings. Any income earned from the excess contribution will count on your tax bill, which is due the following April.
Can I close my 401k and take all the money? ›
You can make a 401(k) withdrawal in a lump sum, but in most cases, if you do and are younger than 59½, you'll pay a 10% early withdrawal penalty in addition to taxes. You can take a 401(k) loan against your balance but will be subject to penalties if you default.
At what point should you stop contributing to a 401k? ›
A general rule of thumb says it's safe to stop saving and start spending once you are debt-free, and your retirement income from Social Security, pension, retirement accounts, etc. can cover your expenses and inflation. Of course, this approach only works if you don't go overboard with your spending.
Do you lose company match if you max out 401k? ›
If you max out your 401(k) early in the year, you could miss part of your employer match, experts say. But some 401(k) plans offer a “true-up,” or additional deposit of the remaining employer match if you max out contributions before year-end.
What happens if I go over my 401k contributions? ›
Unless timely distributed, excess deferrals are (1) included in a participant's taxable income for the year contributed, and (2) taxed a second time when the deferrals are ultimately distributed from the plan.
Can I contribute to an IRA after I max out my 401k? ›
It usually makes sense to contribute enough to your 401(k) account to get the maximum matching contribution from your employer. But adding an IRA to your retirement mix after that can provide you with more investment options and possibly lower fees than your 401(k) charges.
