Living comfortably in retirement is a crucial part of the traditional American Dream. But many Americans struggle to save enough before they leave the workforce. According to a 2021 survey from the Insured Retirement Institute, 51% of older workers don’t have enough saved to cover their retirement needs. And, in addition, 57% are not saving enough to make up for it. With that in mind, it might be time to consider your current savings plan. One way to reach your financial goals is to max out your 401(k) to support yourself through retirement. Here’s what you need to know to see if this strategy suits your situation.
Consider working with a financial advisor as you prepare for retirement.
Should You Max Out Your 401(k)?
The answer is: it depends. The 2021 401(k) contribution limit is $19,500 (and $20,500 in 2022). Individuals over 50 can also add another $6,500 in catch-up contributions. Of course, you want as much as possible waiting for you in your golden years, so why not hit the cap? But retirement isn’t the only financial goal you probably have. Think about the big picture; where else do you need to put your money?
Because of your personal situation, maxing out might not make sense for you. But that doesn’t mean you won’t have enough. Building adequate savings doesn’t require you to meet the contribution limit. Even if you don’t max out your 401(k), you can still maximize your savings.
One opportunity your workplace might offer is a match contribution program. According to Fidelity’s 2020 Facts & Insights, 86% of employers offer a retirement plan contribution to their employees. In addition, the report shows that employers contribute 4.6% on average. So, there are significant funds waiting for you if you take advantage of an employer match.
Moreover, the match usually comes as part of your plan. That means opting out of the match costs you money that your employer would otherwise owe you.
Of course, you can always increase your own contributions as well. Like this, you can still grow your 401(k) without maxing it out.
Consider This Before You Max Out Your 401(k)
The decision to max out your 401(k) won’t be the same for everyone. Your personal situation should determine what you do with your retirement account. Use these following examples to help you decide your next contribution amount.
Pay Off High Interest Debt
If you currently carry any debt, like a mortgage or a car loan, consider the interest rates attached to each one. If any of your debts come with interest higher than your 401(k)’s rate of return, it’s possible that you may lose money.
For instance, let’s say you have a 401(k) plan that provides returns around 9% on the amount you invested. However, you have a student loan with a 12% interest rate. As a result, you may be paying more to cover the interest on the student loan than you earn through the 401(k) plan.
So, it may be worth it to pay down debt first before contributing to a 401(k). Then, once the debt’s paid off, you can focus more of your wealth on the retirement saving plan.
Put Money in an Emergency Fund
Unfortunately, your 401(k) comes with rules that limit your ability to use the funds. For the most part, you can’t withdraw funds early without paying some penalty. Because of this, it may be worthwhile to put some of your money into an additional savings account. That way, you have instant access when you’re strapped for cash.
Financial planners call this an emergency fund. Usually, it’s recommended that your emergency cover a minimum of three to six months. However, that may change depending on your circumstances. When you build your emergency fund, consider the necessary expenses you face every month. Then, create a financial cushion that could cover multiple months’ worth of these expenses. The exact amount should be enough to sustain you for a limited period if you experience a drastic change in your life, such as job loss or sudden medical bills.
Balance All Savings Goals
Retirement is an important savings goal, but you probably have other things you want as well. Comparatively, you may have more short-term goals you’re saving for, like a vacation, a new car or home renovation. You don’t have to put all those aspirations on the back-burner for the sake of your retirement. Instead, try splitting up your contributions. Put some money into the 401(k) and some toward your upcoming goals.
You may also need to rethink your contribution amount depending on your age. Younger workers have decades ahead of them before retirement. So, don’t feel like you have to max out from the get-go. Find a contribution amount you can comfortably afford; saving shouldn’t be a financial burden.
Remember: you don’t have to stick to one amount forever. Regularly reconsidering your contribution amount will ensure all your needs are met. As time goes on, you can consider ways to increase your saving amount if that suits you.
Where Should You Save Money After Maxing Out Your 401(k)?
You might decide that maxing out your 401(k) is the right financial move. But that’s not the only way to maximize your retirement savings. If you find yourself already meeting the cap on your 401(k), consider these alternatives so you can continue stockpiling funds.
Pension (Defined Benefit) Plan
Pension plans, which are defined benefit plans, guarantee a fixed monthly income during retirement. This is different from a 401(k) plan, which depends on your own contributed funds leading up to retirement. Typically, a pension plan requires you to work for a specific employer for a certain number of years. As a result, you become eligible to receive the pension’s full amount.
However, you can create a pension of your own by purchasing an immediate annuity. With an immediate annuity, you pay an insurance company a one-lump sum. In turn, the company sends you a regular check for the rest of your life.
Individual Retirement Account (IRA)
An IRA is probably the first place workers should look after maxing out their 401(k). Regardless of whether you contribute to a traditional IRA or a Roth IRA, your money grows tax-free. In addition, both come with tax advantages.
Roth IRAs allow you to make contributions with after-tax dollars. So, you can withdraw funds without facing income tax, unlike 401(k)s or traditional IRAs. On the other hand, traditional IRAs give you have the opportunity to lower your annual income tax. You simply deduce the amount you contribute from your income, as long as your income sits below a specific level.
The 2021 and 2022 contribution limit for traditional and Roth IRAs is $6,000 (or $7,000 if you’re 50 years old or older.
Health Savings Account (HSA)
Another alternative is a health savings account. This may be available to individuals with a high-deductible health plan. An HSA allows you to set aside pretax money to pay for eligible medical costs, like deductibles, coinsurance, copayments and more.
HSAs come with multiple benefits, such as earning tax-free interest, potential investment options, no penalties after age 65 and funds roll over between years.
For the 2021 plan year, an individual can contribute up to $3,600, and family coverage allows contributions up to $7,200. The 2022 limit is $3,650 and $7,300, respectively.
Investment Options
Suppose you maxed out your retirement savings accounts and decide you want to further grow your wealth. In that case, it might be time to think about investing.
There are low-risk investment options out there, such as municipal bonds, which allow you to bulk your finances without major risk of loss. They are also liquid investments, which means that you can easily sell them, and their interest does not face federal taxation. Interest may also avoid state or local taxes depending on where you live. Other low-risk investments include savings accounts, CDs and bonds.
Alternatively, if you want to prioritize wealth, there are higher-risk investments. Some options include stocks, exchange-traded funds (ETFs), real estate.
The Takeaway
You want to ensure you have a big enough nest egg waiting for you in retirement. But everyone faces unique financial needs and wants. So, maxing out your 401(k) may or may not be necessary to have your ideal retirement. Before you make any decisions, consider the potential advantages and drawbacks of maxing out your 401(k) contributions. If you’re not sure whether it fits into your financial strategy, speak to a financial advisor. They can lay out your options and help you create a savings plan that works for you.
Tips for a Financially Successful Retirement
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Managing your investments and retirement accounts isn’t easy. Circumstances may even require you to change your current strategy. If you need help, a financial advisor can guide you through the financial field and introduce you to new savings tactics. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Each state follows unique retirement tax laws. Keeping them in mind during your retirement planning process is vital for any worker. Educate yourself to maximize your savings’ value and reduce your overall tax burden.
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