The IRS restricts how much you can contribute to 401(k) plans each year because they provide such significant tax benefits. However, the potential for earning a 401(k) is still very substantial due to the fact that it allows for investment, compounding interest, and tax deferrals. In 2023, 401(k) plan participants can contribute up to $22,500 to their accounts. If you're at least 50 years old, the IRS will allow you to contribute more money. These are called “catch-up” contributions. In 2023, a $7,500-catch-up-contribution is allowed by the IRS. This is an addition to the $22,500 base which is equal to the total limit of $30,000 for 50-years-olds and up. For Roth IRAs, younger people can only contribute a maximum of $6,500 to their IRAs. American citizens age 50 and up can contribute up to $7,500 in an IRA. Have questions about a maxed-out 401(k) or Roth IRA? Click here. You should max out your 401(k) and Roth IRA because they provide a great way to save money. 401(k) plans aren't taxed until you withdraw the funds, which means those dollars grow faster than they would if those dollars were close to what you actually earnedWhat Does It Mean to “Max Out” Your 401(k) And Roth IRA?
Why Should I Max Out My 401(k) and Roth IRA?
Benefits of Maxing Out Your 401(k) and Roth IRA:
- 401(k) plans don't withhold taxes until you withdraw the funds, meaning that your tax bracket is likely to be lower when you retire than it is now.
- You have more money saved for retirement, which means that you have a better chance of being able to retire comfortably.
- Maxing out your plan offers an immediate pay raise because you're able to save more.
Places to Save After Maxing Out Your 401(k) and Roth IRA
1. Establishing Your Emergency Funds
An emergency fund is a sum of money that you keep saved in cash.
It's what you'll use if something unexpected were to happen, such as getting into an accident and having your car damaged or stolen.
It doesn't matter what your income is: everyone should have some money put aside for emergencies.
If you're just starting out and don’t have a lot of money, commit to saving what you can.
In fact, what would really be ideal is if you could save up half of what an emergency will cost and then pay the rest with your credit card.
2. Open a Health Savings Account (HSA)
An HSA is a type of savings account that works with your health insurance.
It allows you to save money for medical, dental, and vision expenses tax-free.
You can open an HSA if you have what's called a high deductible health plan (HDHP).
An HDHP has a deductible of what's called a minimum annual value (MAV).
The MAV is what you have to pay out-of-pocket for your health care each year before your insurance kicks in.
In other words, it's what you have to pay before the HDHP coverage comes into play.
You can save money tax-free.
You don't have to worry about the IRS taking what you've saved if something happens; what's in your account is yours for good.
3. Invest in a Brokerage Account
If you're over what's called the age of 59.5, then what goes in your brokerage is yours to keep for good.
If you are under the age of 59.5, what you invest in your brokerage is what's called a “constructive receipt”.
This means what's in your account is what the IRS considers income.
A brokerage account allows people to invest after-tax money in the stock market, just like a typical 401k, except that it happens after tax.
Any capital gains levied at withdrawal. Each trade made by the investor incurs a brokerage fee.
The Bottom Line
Don't believe that you must quit saving once you've used up all of your company's 401(k) contributions for the year.
This might be a mistake that prevents you from achieving your retirement objectives.
There are other long-term possibilities for accumulating assets.
If you're young, what you should do first is save what you can.
Put aside what you have to in order to reach the minimums of your company's 401(k).
If what's left over is too much for a traditional catch-up contribution, then open a Roth IRA.
If what's left over after maxing out your 401(k) and Roth IRA is what you'll use to pay off debt or invest in general, what you should do first if what's left over is what you'll use for retirement because those dollars grow tax-free.
Maxed Out 401(k) and Roth IRA FAQs
Review what's your company policy regarding what you'll need to do to be able to invest what's left over that hasn't been used. If what's left over is less than what that the IRS allows, then put what you can into a Traditional IRA and what remains in a Roth IRA.
Employer or not, you can still invest in a traditional IRA. It's possible to open a Traditional IRA at a brokerage even though you do have an employer offering a plan. If what your annual income is too high to qualify for the tax benefits offered by an IRA, then consider the Roth IRA. It doesn't offer any tax breaks, but what you do get is that your investments are yours for good once they're inside the account.
If there's a match from your employer, then contribute as much as you can up to the maximum. If what's left over can't be contributed to a Roth IRA, then consider contributing it to a brokerage account. Just take note of what you'll need to pay in order for the capital gains to be considered tax-free earnings.
If your income is too high to contribute money to an IRA and what you want to do with the contributions is invest in stocks, then consider investing in a dividend reinvestment plan (DRIP). Income from this type of investment isn't taxed until it's withdrawn.
A Roth IRA is a particularly useful savings tool for younger savers because it allows them to save more than what's allowed in a traditional, tax-advantaged account like a 401(k), 403b or 457.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.
