Should You Max Out Your 401(k)?

Personal Finance 101 holds that one of your top priorities as a retirement saver should be to contribute at least enough to your company’s 401(k) plan to take advantage of any matching contributions made by your employer. For example, if your company will match 50% of any contributions you make up to 6% of your salary, you’d want to set aside 6% of your salary at minimum. Contributing an amount up to the company match is the easiest way to ratchet up your retirement savings and take advantage of the “free money” your employer is chipping in.

This advice makes perfect sense, but after meeting this threshold, most employees will still need to decide whether to contribute more than that. In 2024, the annual limit for 401(k) contributions rose to $23,000, up from $22,500 previously. Employees who are age 50 and older are eligible for annual catch-up contributions of up to $7,500, or a total of $30,500. That’s a lot of money, which might lead to the question, Am I saving too much?

While most retirement savers don’t need to worry about oversaving, there are some cases where it might make sense to not invest the maximum in a 401(k).

Reasons Why You May Not Want to Max Out

1. The plan has high costs and/or poor-quality investment options. Across the retirement industry, the majority of plan participants pay less than 80 basis points in combined costs (including administrative fees for the plan plus expense ratios for the underlying investment options). But costs span a wide range. If you work for a smaller employer, you’re more likely to be saddled with a higher-cost plan.

2. You need liquidity for shorter-term goals. When you invest in a 401(k) plan, your contributions are effectively off-limits until age 59½ (or 55 for retirement plan participants who have separated from service). Any withdrawals made before then are generally subject to a 10% early withdrawal penalty, in addition to taxes on ordinary income. Many employers will allow you to borrow a portion of your 401(k) balance, but loans typically need to be repaid with interest within a five-year period.

This means that it’s worth thinking through all of the other life goals you might want to fund before you retire. If you contemplate buying a house, paying for a child’s college education, or retiring significantly before age 59½ (or 55, as noted above), for example, it’s best to invest elsewhere.

3. You need to pay down high-interest debt, such as credit card debt. The average credit card currently has an APR of more than 20%, which is well above the amount you could reasonably expect to earn on a diversified portfolio in any given year. That’s why it almost always makes sense to funnel extra cash toward paying down high-interest debt instead of maxing out 401(k) contributions.

4. You haven’t yet funded a Roth IRA or an HSA. Roth IRAs are especially attractive for younger individuals in the early stages of their careers, who are more likely to be in lower tax brackets. People under certain modified adjusted gross income limits (currently $146,000 for single filers and $230,000 for married couples filing jointly) can contribute up to $7,000 per year (or $8,000 for people age 50 and older) to a Roth IRA. (If your company offers one, a Roth 401(k), which has the same contribution limits as a regular 401(k), could also be an option.)

There’s no upfront tax deduction, but you won’t have to pay any taxes on growth or withdrawals from the account as long as you’ve held it for at least five years and are at least age 59½. Roth IRAs also offer more flexibility than other retirement accounts in that you can access previous contributions (albeit not growth on the account) even if you’re younger than age 59½.

Healthcare savings accounts (which have an annual contribution limit of $4,150 for individuals or $8,300 for family coverage, both of which require coverage under a high-deductible health insurance plan) are even more attractive. Contributions reduce taxable income upfront, and account growth is tax-free. Any withdrawals made from the account are also tax-free as long as they’re used for qualified medical expenses. This triple tax benefit makes HSAs a more compelling vehicle for long-term growth than 401(k)s, which have a higher contribution limit but will eventually be subject to ordinary income taxes on required minimum distributions and other withdrawals.

5. You expect to be in a higher tax bracket in retirement. Most investors have less taxable income after retirement, but if you’ve been diligent about socking away retirement savings for many years, you could eventually end up with a large portfolio balance that will be subject to required minimum distributions starting at age 73 (or age 75 starting in 2033). For example, a 73-year-old single filer with a $2 million retirement portfolio would be subject to a starting required minimum distribution of about $75,500, which could potentially tip someone into a higher tax bracket when combined with other income, such as Social Security, investment income, and/or pension income.

Future tax rates are another question mark. The Tax Cuts and Jobs Act lowered tax rates by 2 to 3 percentage points across most income levels starting in 2018. Unless Congress takes action to extend these tax cuts, tax rates will revert to previous levels starting in 2026. Given the ballooning budget deficit, it’s conceivable that income could be taxed at even higher rates in future years.

Reasons to Consider Maxing Out

Now that we’ve talked about some of the cases in which it might not make sense to invest the maximum in a 401(k), let’s review situations in which it does make sense to max out.

1. You’re running behind on retirement savings. Statistically speaking, most retirement savers aren’t socking away anywhere close to enough money to create tax issues further down the road. Based on data from Vanguard’s How America Saves report, the average 401(k) plan participant between 55 and 64 has an account balance of roughly $208,000. The median balance is only $72,000.

Given these balances, the average retirement saver is more likely to be undersaving than oversaving. If you’re one of them, you can take advantage of the “catch-up” contributions I mentioned above to shore up retirement savings starting at age 50.

2. You plan to implement a tax strategy to minimize taxes on RMDs. Even investors who manage to build up larger 401(k) balances typically have an opportunity for at least several years after retirement to do Roth conversions. Most investors who own a deferred account such as a 401(k) or traditional IRA are required to start taking required minimum distributions beginning at age 73 (specifically, by April 1 of the calendar year following that birth date). Starting in 2033, this age requirement will extend to age 75.

This gives you a long runway to make Roth conversions, which involve selling part of an IRA and transferring the proceeds to a Roth IRA. Balances held in a Roth IRA aren’t taxable (even if sold) and are not subject to RMDs. For example, an investor who retired at age 65 could roll over their 401(k) into a traditional IRA and then make a series of annual Roth conversions over the next eight to 10 years. Each year’s conversion would trigger ordinary income taxes, but likely at a lower tax rate than when you were employed. Making a series of Roth conversions after retirement but before RMDs kick in is a way to lower the account balance that will eventually be subject to RMDs and in turn, reduce taxable income over time.

Delaying Social Security payments until age 70 is another way to facilitate this strategy. Skipping out on Social Security payments in earlier years reduces taxable income, which creates more space for filling up brackets with income from Roth conversions.

3. You expect to be in a lower tax bracket after retirement. As mentioned above, most retirement savers have less taxable income after they stop working. In addition, income taxes are based on marginal tax rates, not flat rates. If you’re a single taxpayer in the 24% tax bracket, for example, you would pay taxes on 10% of your taxable income up to $11,600, plus 12% of the income between $11,600 and $47,150, plus 22% of the income between $47,150 and $100,525. The 24% rate would only apply to income above $100,525 (and below the cutoff for the next bracket, which is $191,950). The end result is that the combined tax rate (also known as the effective tax rate) is lower than the marginal rate, and the tax burden on RMDs may not be as bad as some retirees fear. This also creates an opportunity to do strategic Roth conversions to “fill up” lower tax brackets without tipping into a higher bracket.

Conclusion

Saving for retirement is sort of like eating vegetables: If you’re eating several pounds of produce per day and suffering adverse effects, you might be overdoing it. But the average person is probably far more likely to need more retirement savings rather than less.