There's a simple reason people are advised to build up nest eggs for retirement. Once you leave full-time work behind, you'll need more than just your Social Security checks to cover your living expenses.
If you've been an average earner over the course of your career, you can expect your Social Security benefits to replace about 40% of your pre-retirement wages. But that's not a whole lot to live on. So the smart move is to steadily build up a portfolio of assets that you'll be able to use to supplement those benefits.
In that regard, a 401(k) plan can be a great place to start, if you have access to one. Many of the employers that sponsor them also match workers' contributions to some degree, boosting the value of your contributions. Plus, the annual contribution limits for 401(k)s are much higher than the limits for IRAs, so you can use them to save more and benefit more from the tax advantages that they offer.
In fact, 401(k) contribution limits are rising quite a bit in 2023 due to high inflation. But should you max yours out? Not necessarily.
A bigger opportunity to fund your retirement nest egg
In 2022, 401(k) plan contributions top out at $20,500 for those under 50 and $27,000 for those 50 and older. That higher limit for older savers is due to "catch-up contributions" of up to $6,500 a year that they're allowed to make. (And to be clear, you don't need to be "behind" on your retirement savings in any sense to make those catch-up contributions -- you just need to have turned 50.)
In 2023, workers under 50 will be able to contribute a total of $22,500 to a 401(k). That's an almost 10% increase. Meanwhile, the cap on catch-up contributions will rise from $6,500 to $7,500. So all told, workers 50 and older will have the option to put up to $30,000 into a 401(k) next year.
Should you max out your 401(k)?
If your employer offers to match some percentage of your 401(k) contributions, then it pays to put in at least as much money as it takes to snag those matching funds in full. But beyond that, there are reasons you may want to find a different vehicle for some of your retirement money.
One drawback of 401(k)s is that they tend to limit your investment choices. In many cases, rather than allowing you to buy individual stocks, you'll only be allowed to pick from a fairly small menu of mutual funds and exchange-traded funds.
But those fund choices may not align well with your risk tolerance or your goals. Some also might come with exorbitant fees that will eat away at your returns. (Though it's worth noting that 401(k)s commonly offer some options for investing in index funds, the fees of which tend to be far more reasonable.)
That's why you shouldn't necessarily plan to max out your 401(k) in 2023. A better bet may be to divide your retirement investments between a 401(k) and an IRA. The latter option offers you significantly more flexibility in how you can invest your money.
The fact that the IRS has given the 401(k) contribution limits for next year a big boost is a good thing. But that doesn't mean that taking full advantage of that higher ceiling will be the right call for you. Ultimately, you'll want to take a close look at what investment options your 401(k) offers before deciding if that account is where you'll want to put all your retirement savings in 2023.