You'll often hear that the more money you manage to save for retirement, the more comfortable your senior years are likely to be. With that in mind, you may be thinking about increasing your 401(k) plan contributions this year. But before you go that route, make sure to run through these key questions.
1. Do I have money for emergencies?
You never know when your car might break down or when a major system in your home, like your heat, might fail and require a complete replacement. You also never know when you might lose your job.
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That's why it's so important to have money in the bank for emergencies like these. And ideally, your emergency fund should be robust enough to get you through three months of living costs in the absence of a paycheck, at a minimum.
If you're not there yet, then you shouldn't put more money into your 401(k) until you're better protected against near-term unplanned costs. A $50,000 balance in your 401(k) may not do you a lot of good if you need $1,000 for a vehicle repair and you can't access that money.
Of course, some 401(k) plans do allow for hardship withdrawals. But a hardship withdrawal doesn't automatically mean you're exempt from paying the 10% early withdrawal penalty that generally comes with removing funds from a 401(k) before age 59 1/2.
Also, some 401(k) plans do allow savers to borrow against their balances. That may be your backup plan instead of an emergency fund, but it's frankly not a great one.
Even if your retirement plan allows for 401(k) loans, these can be risky. If you don't pay yourself back in time, your loan will generally be considered a withdrawal, making it subject to the aforementioned early withdrawal penalty. So, all told, you're better off prioritizing your emergency savings and then increasing your 401(k) contributions.
2. Have I gotten my complete employer match already?
Many companies that sponsor 401(k) plans also match worker contributions to some degree. It's absolutely a good idea to contribute enough to your 401(k) to snag that match in full. But beyond that, you may want to look to invest for retirement elsewhere.
One major drawback of saving for retirement in a 401(k) is that you generally can't invest in individual stocks and are often limited to a bunch of different funds. That could result in hefty investment fees that eat away at your returns.
As such, once you've claimed your full 401(k) match, you may want to look to an IRA for retirement savings purposes. You may find that you're given a much wider range of investment choices that not only help you minimize your fees but assemble a portfolio that's more in line with your investment style.
3. Am I neglecting other tax-advantaged accounts I'm eligible for?
You might assume that a 401(k) plan is the best place for your retirement money if you've never been eligible for an HSA before. But if your health plan changed this year and is now HSA-compatible, then it definitely pays to take advantage of the opportunity to contribute to one of these accounts.
This year, the requirements for an HSA for self-only coverage are:
- Having a minimum deductible of $1,600.
- Having an annual out-of-pocket maximum of $8,050.
If you have family-level coverage, this year's HSA requirements are:
- Having a minimum deductible of $3,200.
- Having an annual out-of-pocket maximum of $16,100.
The upside of funding an HSA is that you get three tax benefits:
- Contributions go in tax-free.
- Investment gains are tax-free.
- Withdrawals for qualified medical expenses are tax-free.
You also get the option to tap your HSA in the near term to cover healthcare expenses or invest your money and let it grow for the future. There's no expiration date on HSA funds, so an HSA can very easily double as a retirement savings plan for you, especially since you can take withdrawals for non-medical purposes without penalty at the age of 65. In that case, withdrawals are subject to taxes, but that's no different than traditional 401(k) withdrawals.
It's definitely not a bad thing to aim to save more for retirement. But before you fund that 401(k), make sure to answer these essential questions to see if that's really the right move.
