Maxing out your 401(k) is already a challenging feat, and it's about to get even more difficult next year, as limits rise to $22,500 for adults under 50 in 2023. Adults 50 and older will be able to contribute a whopping $30,000.
But that's a lot of money to lock away, possibly for decades. Is maxing out your 401(k) next year actually a good idea? Here's a look at the pros and cons to help you decide.
Image source: Getty Images.
Pros of maxing out your 401(k) in 2023
Maxing out your 401(k) increases your retirement readiness considerably. A $22,500 contribution in 2023 would be worth nearly $340,000 in 2033, assuming an 8% average annual rate of return. That's enough to cover several years of retirement expenses for most people. And you could wind up with even more if you make catch-up contributions or earn a 401(k) match.
Plus, you'll also get a tax break this year if you're contributing to a traditional 401(k). So if you earn $80,000 from your job in 2023 but put $22,500 in your 401(k), the government will only tax you on the remaining $57,500.
This doesn't apply to Roth 401(k) funds, however. Roth 401(k)s require you to pay taxes on your contributions upfront, but they allow for tax-free withdrawals in retirement.
Cons of maxing out your 401(k) in 2023
As discussed, putting money in your 401(k) limits your access to these funds, possibly for decades. With few exceptions, you can't make a withdrawal if you're under 59 1/2 without paying a 10% early withdrawal penalty on top of taxes. So it's not the ideal place to put your money if you plan to use it sooner.
Some 401(k)s also charge high fees and limit your investment options. This can slow the growth of your savings over time. In that case, a 401(k) might not be the best place for your retirement funds. You might prefer to save in an IRA or even a health savings account (HSA). Both of these accounts have lower annual contribution limits, but they allow for greater flexibility in what you invest in.
If you don't want to stash all your money in a 401(k), you could use multiple accounts. You might put money in your 401(k) first until you've gotten your employer match. Then, you could switch to an IRA until you've maxed that out. Or you could put some money in a taxable brokerage account if you want some money you can access before you turn 59 1/2.
So should you max out your 401(k)?
It's ultimately your call if you want to try to max out your 401(k) in 2023. But make sure you understand the pros and cons before doing so, and compare your 401(k) to all the other retirement accounts you have available to you.
Don't be afraid to change your plan if your circumstances change next year. Just do your best to make regular retirement contributions to some account so you can improve your financial security for the future.
