Maxing out your 401(k) is an impressive retirement achievement. In 2023, that means putting $22,500 ($30,000 if you're over 50) toward your future, which could easily grow into hundreds of thousands after it's been invested wisely for a few decades. But that doesn't necessarily mean you should do it.
While 401(k)s have a lot of benefits, they have their drawbacks too. If any of the four things listed below are a major problem for you, you might want to seek other retirement accounts to hold your cash.
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401(k)s limit your investment options
Your 401(k) plan provider determines what you can invest your 401(k) funds in. A lot of the time, that's a mix of index funds and target-date funds. The idea is to keep things pretty simple for those who don't know a lot about investing. But that's not what everyone is looking for.
Those who want to invest in specific stocks might prefer to keep their cash in an IRA that enables them to invest their funds. IRAs give you additional flexibility to invest how you'd like and change your investment strategy as needed.
An IRA might also be a better choice if your 401(k) primarily offers funds with high expense ratios. These are annual fees, charged as a percentage of your assets, that everyone invested in the fund pays to the fund manager. You can find out how much you're paying in fees by checking your prospectus. Ideally, you want to keep this under 1% whenever possible.
401(k)s might not give you a choice about when to pay taxes
Most 401(k)s are tax-deferred, which means you get a tax break in the year you make contributions and pay taxes on your withdrawals later. This suits those who believe they'll be in a lower tax bracket in retirement than they're in today. But it's not always desirable for those who think they'll be in the same or a higher tax bracket in retirement.
These individuals might be better off with a Roth IRA. Roth 401(k)s exist too, but they're less common. If you're lucky enough to have one, this could be a better move if you want tax-free retirement withdrawals.
401(k)s restrict your withdrawals
Once you put money into your 401(k), you typically can't take it out again before age 59 1/2. If you do so without a qualifying reason, like a large medical or educational expense, you'll face a 10% early withdrawal penalty.
This is the case for traditional IRAs as well. Roth accounts are a bit more flexible, allowing for penalty-free withdrawals of contributions at any age, though there are still penalties for early earnings withdrawals.
Those hoping to retire before 59 1/2 might prefer to keep some money in a taxable brokerage account. These don't have the same tax advantages as a retirement account, but there are also no limitations on how much you can contribute or when you can access your funds.
401(k) contribution limits are high
Maxing out your 401(k) is pretty difficult. In 2023, you'd need to set aside $22,500, or $30,000 if you're 50 or older. In 2024 those limits will climb to $23,000 and $30,500, respectively. Most people don't have that kind of cash on hand.
But you don't need to max out your 401(k) every year -- or any year -- to have a comfortable retirement. Any money you set aside for your future, whether in a 401(k), IRA, or other account, will help you in the long run.
If you don't think a 401(k) is the right move for you, that's fine. Start with a traditional or Roth IRA. If you max that out, you can always return to your 401(k) for the rest of the year, or try a non-traditional retirement account like an HSA.
