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When You Should and Shouldn't Max Out Your 401(k)

Is maxing out your 401(k) a good idea?

By Motley Fool Retirement Team – Updated Jan 11, 2024 at 10:01 AM

Key Points

2023 allows a $22,500 max 401(k) contribution, with $30,000 for those 50+ considering catch-ups.
Maximize 401(k) contributions if stable financially, devoid of high-interest debt, and with an emergency fund.
Consider other accounts like IRAs or HSAs after reaching your 401(k) max to diversify tax advantages.

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You are financially stable: It makes little sense to put thousands of dollars into a 401(k) if you're struggling to accomplish basic financial tasks such as paying your bills on time or keeping a roof over your head and food on the table.
You don't have high-interest debt: Your 401(k) returns will rarely, if ever, exceed the interest rate you'd pay on credit cards or payday loans. If you have debt with an interest rate of around 10% or higher, you should generally contribute only enough money to your 401(k) to earn your maximum employer match. Then focus on paying down your debt with your extra money.
You have an emergency fund: You need liquid cash accessible for emergencies to avoid ending up in debt when you face unexpected expenses. You do not want to be forced to withdraw funds from a 401(k) to cover emergencies, especially since you could face penalties for withdrawing funds before age 59 1/2 or you could be forced to sell 401(k) investments at an inopportune time. Save up at least a small emergency fund before contributing anything to your 401(k) and then contribute enough to earn the maximum employer match. After that, divide your spare cash between 401(k) contributions and building an emergency fund with enough money to cover three to six months’ worth of living expenses.
You have considered other types of tax-advantaged accounts: Rather than devoting all your retirement money to maxing out your 401(k), you should consider whether some of your funds should go into a traditional or Roth IRA or a health savings account. These accounts can provide different tax benefits, and, in some cases, more flexibility in what assets you invest in.

If you have the money to max out your 401(k) and have considered the opportunity costs of using your funds for this instead of other financial goals, then spending the money to maximize this tax-advantaged retirement account can make sense.

You'll benefit from the ease of contributing directly via your paycheck and from the tax breaks a 401(k) provides. And, having most or all of your retirement money in one place can make it easier to monitor your portfolio and make sure you maintain the proper asset allocation.