Want to jump-start your nest egg and make saving enough for retirement a whole lot easier? Then maxing out your 401(k) this year might be a smart move for you -- emphasis on might. While it's undeniably great for your retirement savings, there are other factors you need to weigh when deciding whether it's a good choice for you. Here's a look at the pros and cons of maxing out your 401(k) in 2021.
Pros and cons of maxing out your 401(k)
You can contribute up to $19,500 to a 401(k) in 2021, or $26,000 if you're 50 or older. If you keep that money in your retirement account for a few decades, you'll end up with serious cash. A $19,500 contribution that earns a 7% average annual rate of return over 30 years will end up being worth nearly $148,500. That's $129,000 in investment earnings -- enough to cover a few years of retirement for most people.
And if you max out your 401(k) year after year, your balance will grow even faster. You may be able to retire earlier if you want and you'll definitely be able to live more comfortably in retirement than you could if you were saving less.
But $19,500 isn't a small chunk of change and once you put the money in a 401(k), you're largely committing to keep it locked up until you're at least 59 1/2. Withdrawing the money before this age results in a 10% early withdrawal penalty, though there are a few ways around this, like substantially equal periodic payments (SEPPs) or withdrawals for qualifying exceptions, like large medical bills. But for most workers under 59 1/2, the money's not easy to access again once it's in the 401(k). So you need to think the decision through carefully or you could cost yourself money.
Is maxing out your 401(k) a smart move?
Before you decide whether or not to max out your 401(k), ask yourself the following questions.
Will I have enough money left over to cover my expenses and emergencies?
A large retirement contribution isn't worth it if it's going to create financial problems for you today. If you save $19,500 in a year, you'll take home $1,625 less per month. That's great if you can afford to do that, but if not, save as much as you can and keep the rest for your bills.
You also shouldn't put money aside for retirement if you don't have an emergency fund or if you've depleted your emergency fund during the pandemic and haven't replenished it yet. Last year taught us all how important emergency savings are, so stockpiling extra cash in case you lose your job or face an unexpected expense should be your top priority. Once you've set aside at least three months of living expenses, you can return to saving for retirement.
Is my 401(k) the best place for my money?
A 401(k) can help you defer taxes on your savings and your employer may even match some of your contributions, helping you reach your retirement savings goal even faster. But you're also limited in your investment choices and your plan may have costly fees. If that's the case for you, you may prefer to stash money in an IRA first and return to your 401(k) after you've maxed that out.
IRAs provide a lot more freedom in terms of what you can invest in, which in turn gives you more control over what you're paying in fees. You can also decide whether you want to pay taxes on your money now or when you retire so you can choose the strategy that will save you the most. The downside to IRAs is that you can only contribute up to $6,000 in 2021 or $7,000 if you're 50 or older, so you'll need another retirement account if you plan to set aside a large chunk of cash.
What if you can't afford to max out your 401(k)?
If you can't afford to max out your 401(k), that doesn't mean you shouldn't contribute anything. You should always try to get any match your company offers unless you need every dollar you're earning to cover your living expenses. A 401(k) match is essentially a bonus you only get if you put money in your retirement account and once it's gone, there's no getting it back again, so you don't want to miss out.
Figure out how much you can reasonably afford to contribute to your 401(k) each month and start with that. If you're not happy with that amount, try reducing your expenditures right now so you have more cash for retirement. Or look into ways to bring more money in, like pursuing a promotion, switching employers, or starting a side hustle. Then, adjust your 401(k) contribution rate accordingly. Even if you're only setting aside a few hundred dollars a month, it's still better than nothing.
Ultimately, maxing out your 401(k) isn't as important as making regular contributions. It may take you a little longer to reach your retirement goals if you're contributing less, but you can still get there as long as you're focused and make retirement savings a priority.