Putting some of your cash into a 401(k) is usually a good idea. But you may not want to max out your contributions by investing the full $19,500 limit (or $26,000 if you're 50 or over).
Here's the best reason for not investing the full amount allowed in this type of retirement account.
You may not want to max out your 401(k) for this reason
Because a 401(k) has high contribution limits, maxing it out would mean putting most or all of your retirement money into the account for most people; and that could be a mistake.
See, the best reason for not maxing out a 401(k) is that other types of tax-advantaged retirement plans can provide better benefits than 401(k) plans. For example:
- Traditional IRA: A traditional individual retirement account (IRA) allows you to make contributions with pre-tax dollars, just like a 401(k). But you can open an IRA with any brokerage firm or a wide variety of other financial institutions. As a result, you'll have access to a much wider pool of investments than in a typical 401(k), which allows you to invest in only a few dozen funds at most. If you want to buy individual stocks or if the funds in your 401(k) come with high investment fees, an IRA could be a better place for at least some of your retirement savings.
- Roth IRA: A Roth IRA requires you to make contributions with after-tax dollars, but you can make tax-free withdrawals. Putting some money into a Roth IRA allows you to receive income you don't have to pay taxes on as a senior -- and that doesn't count toward determining if Social Security benefits become taxable. Investing in a Roth is a good idea if you expect your tax rate may be higher later in life.
- HSA: A health savings account (HSA) allows you to contribute with after-tax dollars and make tax-free withdrawals for qualifying medical care. If you have a high-deductible health plan and are eligible to make HSA contributions, investing in an HSA comes with more tax savings than a 401(k) and can help you cover expensive healthcare costs as a retiree.
Of course, you will definitely want to contribute enough money to your 401(k) to earn the maximum match your employer provides, if your company offers matching contributions. Otherwise, you'd be passing up free money, and there's no reason to do that.
But, once you've invested and earned the maximum match, you may want to think twice about maxing out your 401(k) if you only have a limited amount of money to save for retirement. The best reason not to max it out is to invest in some of these other accounts. At least take a look at them so you can make an informed choice about whether they're a better place to house part of your savings.