With 1 in 5 Americans having no retirement savings at all and 1 in 3 having less than $5000, it is no wonder that the rallying cry of many financial advisors is to save, save, save. However, maxing out contributions to employer-sponsored or individual retirement plans is not always the best option for everyone. If you are wondering if you should always max out contributions to your 401(k), the simple answer is that it depends on your financial situation.
What is a 401(k)?
A 401(k) is a type of retirement savings account that is sponsored by your employer. With each paycheck, you have the opportunity to directly contribute a part of it into your retirement investment account. Much like a traditional IRA, you will not pay taxes on your contributions until you begin withdrawing the funds at retirement.
401(k) plans typically offer a range of mutual funds that contain varying percentages of stocks, bonds, and money market funds. You review the available options and make the selection that makes the most sense for you.
Additionally, many employers will offer a 401(k) percentage match or a flat percentage contribution. Sometimes, you must contribute a certain amount before the company match kicks in. If you have the matching option, a 3% match means that the employer will contribute a maximum of 3% of your annual salary to your 401(k) retirement account.
Example: Your annual salary is $50,000 and you have a 3% 401(k) employer match. Your employer will match up to $1,500 (.03 * $50,000 = $1,500).
You can contribute more than what the employer will match, up to $19,000 in 2019 if you are under 50 and up to $25,000 if you are age 50 or over. Investopedia has a more detailed table on 401(k) contribution limits.
So, should you always contribute the maximum of $19,000 or $25,000 to your 401(k)?
Consider your financial situation and your financial goals
If you are a recent college graduate paying down student debt, a high-interest credit card bill, and you’re making an entry-level position’s salary, it is unrealistic to expect that you will be able to comfortably afford a contribution of $19,000 a year. Even if you have been in the workforce for several decades, this still may not make sense for you. Before you allow the financial stress of maxing out your 401(k) to kick in, consider what your current state of affairs is and what your non-retirement financial goals are.
If you have credit cards with extremely high interest rates or you have taken out payday loans, it often makes sense to pay off these debts before maxing out your 401(k) contributions. If the interest rate on your debt is higher than your expected investment returns, it may be wise to prioritize paying off the debt.
Taking money out of retirement accounts early comes with penalties. Having an emergency fund built up with coverage for 3 to 6 months of living expenses may allow you to avoid touching retirement funds and incurring those early withdrawal penalties.
Health, Life, and Disability Insurance
Prioritizing insurance can help you avoid incurring larger expenses in the future, which also means you are less likely to dip into retirement funds early or take on high-interest debt.
Other Financial Goals
Many of us have several financial goals in addition to saving for retirement. Before you max out your 401(k), take into account whether you are saving for a down payment on a home, your children’s education, or some other personally significant goal.
So, should you always max out your 401(k)?
In light of the aforementioned information, no, you should not always max out your 401(k). Saving for retirement is essential, but that is usually not the only financial goal that people have. Weigh the benefits and tradeoffs, speak with a financial advisor, and then decide if maxing out your 401(k) contribution is the right action for you.
The opinions expressed herein are those of Morris Financial Concepts, Inc. (“MFC”) and are subject to change without notice. This material is for informational purposes only and should not be considered investment advice. MFC is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about MFC including our investment strategies, fees and objectives can be found in our ADV Part 2, which is available upon request. MFC-19-17.