What to Do If You Can’t Max Out Your 401(k)

Today the 401(k) is a standard way Americans save for retirement. Because these plans offer tax benefits and potential employer consideration, many investors aim to maximize their contributions or contribute up to the annual Internal Revenue Service (IRS) limit.

For 2022, the contribution limit is $20,500 per year for workers under age 50 and $27,000 for those age 50 and over. However, many employees can only contribute up to the limit, depending on their personal financial situation. Others may find that maxing out a 401(k) isn’t ideal if the plan’s asset options don’t align with their goals.

In this article, we’ll look at how your 401(k) maximum works and what you can do if you can’t contribute up to the limit.

Key points to remember

  • A 401(k) offers tax benefits and matches from potential employers, so many investors aim to maximize their contributions.
  • Contributions to a 401(k) are made with pre-tax funds, so they reduce your taxable income.
  • You may not want to max out your 401(k) if your employer’s plan offers limited investment choices and high fees.
  • Financial advisors often recommend contributing at least up to the employer’s level.
  • In general, consider contributing as much as you can to a 401(k), even if you can’t contribute the maximum.

Should you maximize your 401(k)?

When you maximize a 401(k), you maximize your tax benefits and create more financial security for your retirement. Your contributions to a traditional 401(k) plan are deferred tax, so you won’t pay any tax on them until you retire them (when you’ll probably be in a lower tax bracket, anyway). With a Roth 401(k)you contribute after-tax money, but you can make tax-free withdrawals in retirement.

Some employers will also matching contributions up to a certain percentage of your salary. For example, if you put $5,000 into your 401(k), your employer can also contribute $5,000.

Potential Disadvantages of Maximizing a 401(k)

But maximizing a 401(k) isn’t necessarily ideal for all investors. In fact, only about 3.6% of workers max out their 401(k), according to the IRS.

Some investors may not have the cash to deduct the maximum contribution from their salary. They may need to use their income for necessary expenses before saving the maximum for retirement.

Also, depending on the company you work for, investing heavily in a 401(k) plan might not be the best choice for you. This is because 401(k) plans offer different investment choices. Since your employer administers the plan, they decide which assets to offer. In some cases, your 401(k) investment options may be very limited.

Finally, some 401(k) plans may not be attractive due to high fees. A 401(k) plan requires management and administration, and 95% of 401(k) plan participants pay fees. Plans with many participants sometimes benefit from economies of scale, so they may have lower fees than those offered by smaller companies. According to a 2021 report, the average fee for a 401(k) account ranges from around 0.88% to 1.19%, but your expense ratio could be much higher.

If your budget is tight, your investment options are too limited, or you have to pay high fees to participate, you may not want to max out your 401(k). You could invest for retirement in other ways, such as through a individual retirement account (IRA) or a standard brokerage account.

How much should I contribute to my 401(k)?

If you decide to invest in your 401(k), you will also need to decide how much you want to contribute from your salary. For the most part, the fiscal advantages and employer matching make a 401(k) the best place to invest for retirement.

A general rule is to aim for save 15% of your income for retirement. If 15% of your income exceeds the 401(k) contribution limit, then you will need to invest your funds in another account to maintain that percentage of savings for retirement.

If you can’t afford to max out a 401(k), try contributing what you can. Investing just a few hundred dollars a year can help provide a source of funding for retirement. If your employer offers matching contributions, try to contribute at least up to the limit of these so as not to leave “free money” on the table.

Before contributing to your 401(k), consider paying off high-interest debt, building up emergency savings to cover unforeseen events, and making sure you’re on track to meet your financial goals. short-term (like getting married or buying a house) . After that, you probably want to put everything you can afford into your 401(k).

Should I max out my 401(k)?

In most cases, you should try to maximize your 401(k). For most people, the tax benefits of a 401(k), along with a potential employer match, will provide strong retirement savings benefits. However, if you’re on a tight budget or your plan has high fees or limited investment choices, you might want to consider investing in another type of account, such as an Individual Retirement Account (IRA).

What are the maximum contribution limits for a 401(k)?

For 2022, the annual limit for employee contributions is $20,500 per year for workers under age 50. However, people 50 and older can earn $6,500. catch-up contribution.

What happens if I can’t maximize my 401(k)?

If you can’t maximize your 401(k), create a budget that aims to set aside as much as possible for your retirement. Consider high-interest debt and other financial obligations when developing an annual savings plan.

The essential

For most workers, a company-sponsored 401(k) is a good option for saving for retirement. However, only about 3.6% of workers max out their 401(k).

There are also circumstances when it makes sense to invest your money elsewhere, such as if your employer offers a limited plan with high fees. In general, however, 401(k) plans offer substantial benefits, so maximizing contributions can increase your savings.