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4 Reasons You Shouldn't Max Out Your 401(k)

By Catherine Brock - Nov 12, 2019 at 11:00AM

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Making high-dollar contributions to your 401(k) can cost you.

The advice, "Go big or go home," can apply to many situations in life, but it's not always the right strategy for your 401(k) contributions. 

Cutting back on retirement savings seems counterintuitive, especially as the U.S. faces a retirement crisis. A recent analysis by The New School's Schwartz Center for Economic Policy Analysis concludes that two of five older workers and their spouses will experience a lifestyle decline in retirement. Specifically, if workers who are currently in their 50s retire at age 62, some 8.5 million people will fall below the federal poverty level. That means their incomes will be less than $23,340 for singles and $31,260 for couples. And the cause of this income decline is -- you guessed it -- inadequate retirement savings.

The maximum you can contribute to your 401(k) in 2019 is $19,000, or $25,000 if you're aged 50 or older. If you keep up with those contributions for 20 years and earn a 7% return, you'll have stored up about $836,000. And that seems pretty adequate, at least as a starting point.

Man working at his desk

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So, how can saving $19,000 a year be a bad thing? Well, in certain scenarios, making those maximum contributions can cost you in other ways. Here are four of them.

1. If you max out too fast, you could miss out on company-match contributions

Many 401(k) plans have a company-match provision, meaning your employer also contributes to your retirement plan based on your own saving activities. You get these free deposits by making your own contributions to the account. Typically, the employer will "match" your contributions dollar for dollar, up to a certain percentage of your salary.

The timing of your company's matching contribution is important, however. Say you make $100,000 annually and your company match is capped at 3% or $3,000. Your employer matches your contributions paycheck by paycheck. You want to max out your own contributions at $19,000 as allowed by the IRS and get your full company match of $3,000. It's a great plan. 

But, if you hit your $19,000 target in November, your final paychecks of the year won't have any further contributions from you. As a result, you won't get your company-match contributions either, meaning you'll fall short of the full $3,000 of matching funds you were eligible for.

Fix this by making sure you don't reach $19,000 in contributions before your final paycheck. You'll need a contribution of at least 3% in that last check to get your full company match.

2. If you have pre-retirement financial goals, you may not have cash available

If you need to put your kids through college, launch a new business, buy a house, or help your parents get settled into their retirement, you may regret locking up your excess funds in that 401(k). Early withdrawals generally result in a 10% penalty. Usually, you have to be 55 years old and retired, or 59-1/2 years old to access your funds. Even if you're 59-1/2 or older and still working, your plan may still prohibit you from taking withdrawals. 

Try setting up automatic deposits into a separate investment account to save for your other financial goals.

3. If you have high-interest debt, you'll incur excess interest expense

Debt is expensive. The national average APR on a credit card is 16.92%. At that interest rate, a $10,000 balance costs you about $139 a month in interest. The faster you pay off that debt, the sooner you get rid of the $139 monthly expense. It makes sense to do this before you contribute hefty amounts to your 401(k).

You may like the 401(k) contributions because the money gets taken out of your paycheck -- which means you can't spend it. That's understandable. Try mimicking that system with automatic deposits to a savings account occurring on your paydays. Then use the savings balance to pay down your credit card debt until it's gone.

4. If your 401(k) plan is a dud, you have better options

Sadly, some 401(k) plans don't have great investment options. You should have your pick of 10 or so mutual funds that each represent different levels of risk. If your plan offers only three investment choices, and one is company stock, you may be better off investing some of your money elsewhere. The same holds true if your plan is charging fees in excess of 1% of your account balance. For details on your fees, check your plan summary.

If your 401(k) plan is a dud, consider contributing some of that cash an IRA to supplement your retirement savings. You have two personal retirement plan options: a traditional IRA or a Roth IRA. Contributions to a traditional IRA give you a tax break today, but then you pay taxes when you withdraw the funds in retirement. Roth IRA contributions don't lessen your tax burden in the current year, but your retirement withdrawals will be tax-free. Traditional and Roth IRAs generally offer broad investment options and have low fees, usually less than 0.5% of your assets annually. The maximum contribution to a traditional or Roth IRA is $6,000 annually for 2019.

Diversify your savings

It's awesome that you have available cash to send to your 401(k). But going big and maxing out those contributions isn't always the right financial move. Keep saving, of course, but diversify to get the most from your company match, add liquidity, pay off debt, or compensate for an expensive or limited 401(k) plan.

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