In 2024, you can contribute up to $23,000 to your 401(k), or up to $30,500 if you are eligible for catch-up contributions because you're 50 or over. That's a lot of tax-advantaged contributions you can make to your plan.
It may be very tempting to sink that much money into your workplace retirement account, if you have it. After all, it's easy to sign up to have withdrawals taken from your paycheck, and you'll see your taxable income decline, so you won't owe as much to the IRS. If you're lucky, your employer will even match a portion of your contributions.
In reality, though, maxing out your 401(k) may actually not be the best financial choice. Here's the truth about why this approach to investing for retirement could end up leaving you with less money than some other alternatives.
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Maxing out your 401(k) means committing to an investment account that may not be the best one out there
For most people, if you're maxing out your 401(k), that's going to take up a good portion of the discretionary income available to you -- so much so that you may not have a lot of money left to put into other retirement accounts, such as a traditional or Roth IRA. And there are a few problems with that.
For one thing, your 401(k) probably has pretty limited investment options, which usually consist of target date and mutual funds. If you want to invest in shares of individual stock, cryptocurrency, or anything besides the limited assets your account makes available to you, you're out of luck.
Another big problem is that you may get hit with fees in your 401(k). The funds you do have available to you might have high expense ratios. You might also have to pay management fees and commissions for buying and selling assets. Fees can really add up when you're investing over a long period of time -- especially if you're paying a percentage of your invested balance and your account is growing.
A third issue is that you may be limited in the type of tax breaks you can claim. If your company offers only a traditional 401(k), you're locked into claiming your tax savings in the year you make your contributions. You can't choose a Roth alternative that allows you to invest with after-tax money but take tax-free withdrawals as a retiree.
All of this means your 401(k) may not be the best retirement account for most or all of your money you're saving for your later years. If that's the case, maxing it out may not be a good idea.
Here's what you can do instead
Rather than just funneling money into your 401(k) by default, take a look at what your other options are. For many people, it makes sense to:
- Invest enough to earn your full employer match so you don't pass up free money.
- Switch over to maxing out a traditional or Roth IRA if you're eligible for tax-advantaged contributions. A traditional IRA offers the same upfront tax savings as a 401(k) but more investment choices. A Roth allows you to defer tax breaks until retirement, so if you expect to be in a higher tax bracket later, it can be a better choice. It also comes with more investment options.
If you still have money left after maxing out IRA contributions, then you can go back to putting it into your 401(k). But don't forego the benefits of taking this approach and diversifying into different account types by just defaulting to dropping every dollar of retirement savings into your workplace plan. If you do, you could come to regret it.
