401(k) Contribution Limits: Maxing It Out May Be a Bad Idea

You might do better by not maxing out those 401(k) contribution limits.

Jul 29, 2014 at 2:15PM
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Source: Flickr user _e.t.

If you have a 401(k) plan available to you at work, or a similar 403(b) or 457(b) plan, you should probably make good use of it in order to ensure a comfortable retirement. Thus you'll probably want to know what the 401(k) contribution limits are for 2014 -- you'll find them below.

But for the best results, you might not want to reach those limits.

First, though, know that 401(k) plans are offered by many employers, and they offer the chance to save money on a tax-deferred basis. You contribute pre-tax dollars, thus reducing your current taxable income, and then are taxed on withdrawals in the future. 403(b) plans are quite similar, designed for employees of public schools, churches, and certain nonprofit organizations. 457(b) plans are designed for employees of city, county, and state government entities, along with public schools and colleges. Below are the 457(b), 403(b), and 401(k) contribution limits for this year:

401(k) contribution limits for 2014

Plan type

401(k)

403(b)

457(b)

Basic limit

$17,500

$17,500

$17,500

Catch-up contribution limit for those age 50 and older

$5,500

$5,500

$5,500*

Total limit for those 50 and older

$23,000

$23,000

$23,000

*Not available to those who work for tax-exempt employers.

Now that you know the 457(b), 403(b), and 401(k) contribution limits, should you try to max them out? That depends.

Aim for the 457(b), 403(b), and 401(k) contribution limits
One way or another, most of us need to save for retirement -- and save a lot. These employer-sponsored plans are handy tools for that, as they can have you effortlessly and automatically deducting contributions from each paycheck. Better still, many employers will match your contributions to some degree. That's free money, which you can't pass up.

Further, 401(k) contribution limits (as well as those for 403(b) and 457(b) plans) are considerably higher than IRA contribution limits, which are $5,500 or $6,500 for those 50 and older. Thus they let you sock away more, and many people will need sizable nest eggs to retire on. For those who wouldn't do well trying to oversee and manage a handful of retirement accounts, these plans can make things quite simple, requiring little work.

Consider undershooting the 457(b), 403(b), and 401(k) contribution limits
On the other hand, you may not want to max these accounts out. These plans have certain downsides, including:

  • They don't always offer the best selection of investments to choose from. For most investors without the time or expertise to manage their money closely, a simple broad-market index fund or two might be all that's needed. Some plans don't offer them, though. Your account's overall performance can suffer if you're invested too conservatively or aggressively. In an IRA, meanwhile, you can invest in stocks or bonds you choose yourself, as well as certain other investments.
  • The investment options are often expensive. On your own, you can find S&P 500-based index funds that charge you annual fees of less than 0.1% per year. Most 401(k)s sport funds that will charge you much more. In fact, you typically pay a management fee to the plan administrator and to the managers of the funds in which you're invested. The Department of Labor has pointed out that a 1% difference in fees can lead to a 28% difference in ultimate earnings over 35 years. (This calculator may be able to tell you how much you're facing in fees through your employer plan.) 

So, given those concerns, what should you do? Well, remember that you can probably fund an IRA, too. Thus you might contribute enough to your employer plan to receive the maximum employer match but then move on to maxing out your IRA contribution. If you're able to save and sock away more, you can think about maxing out your employer-provided retirement account or perhaps contribute to a regular, non-tax-advantaged brokerage account if you see a lot of great investment opportunities out there.

Look beyond the 457(b), 403(b), and 401(k) contribution limits and see whether you should be investing some of your money somewhere else.

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