Should I Max Out My 401(k)?

When to Consider Maxing Out Your 401(k)

Hitting the 401(k) contribution limit for the year could make sense in some cases:

You're a High-Income Earner

A higher income generally makes saving more achievable. For example, it's easier to max out your 401(k) when you make $150,000 a year versus $50,000. Plus, contributing up to the limit may have a bigger impact on your tax bill as your income rises.

That said, a higher income doesn't automatically translate to more available cash. Reviewing your budget is important, especially because lifestyle costs often rise with income. If most of your paycheck is spoken for, then cutting back on nonessential spending creates more room to save.

You've Paid Off All High-Interest Debt

Maxing out your 401(k) makes more sense after you've paid off high-interest debt like credit cards and private student loans. That's because the costs of higher interest often exceed what you'd reasonably expect to earn through investing. After those debts are eliminated, contributing more to your 401(k) allows you to focus on long-term growth, take full advantage of tax benefits, and potentially increase your retirement savings through compounding over time.

You're Behind on Retirement Savings

If you're behind on retirement savings, increasing your 401(k) contributions may help you catch up, especially if you're in your peak earning years. Maxing out your account allows you to accelerate savings in a tax-advantaged account and take full advantage of compound growth over time.

If you're age 50 or older, catch-up contributions can further boost how much you're allowed to save each year. Just be sure higher contributions still fit within your budget so you don't need to rely on credit or derail other financial priorities.

When to Avoid Maxing Out Your 401(k)

In these situations, you might want to avoid maxing out your 401(k):

You Don't Have an Emergency Fund

An emergency fund is a crucial part of your financial plan because it can prevent you from going into debt when large, unexpected costs arise. One rule of thumb suggests saving three to six months' worth of essential living expenses, but the right amount for you may differ.

It's possible to have multiple financial targets, but prioritize the emergency fund until you've reached your goal. In the meantime, you could make smaller contributions to your 401(k) or just enough to receive your employer match.

You're Carrying High-Interest Debt

It typically makes sense to pay down high-interest debt before maxing out your retirement savings. For most people, that means clearing debts with an interest rate of 6% or higher before putting extra money into a 401(k). You could set the threshold a bit higher or lower, but the main goal is to reduce your interest costs.

However, don't put off retirement saving for too long. You'll need a well-stocked nest egg to pay for living expenses once you stop working in your golden years. If your debt has become a burden, consider reaching out to a credit counselor for help.

You're Prioritizing Other Financial Goals

Retirement isn't the only financial goal out there. Maybe you're saving for your child's college education, a mortgage down payment, a large upcoming purchase or another priority. In these cases, it could make sense to contribute minimally to your 401(k) until you hit your short- or medium-term target. Try to continue with smaller contributions to maintain the savings habit, or contribute just enough to receive an employer 401(k) match.

How to Max Out Your 401(k)

Many experts suggest directing 15% of your gross income toward retirement. But that amount can be a stretch if you have a low income or other pressing goals to meet. Try taking these steps:

• Take advantage of the full employer match. Some employers match your contributions dollar for dollar up to a limit, such as a 50% max on up to 6% of your salary. That essentially translates to free money when you save at least the minimum.
• Increase your contributions gradually. Start by contributing enough to qualify for an employer match, if you have one. Then hike up your contributions by 1% per year until you're saving 15%. Consider increasing the savings rate each time you get a raise.
• Automate your contributions. You can typically ask your employer to deduct a set percentage of your pay and direct it to your 401(k). Automating the contributions ensures you never forget.

Frequently Asked Questions

The Bottom Line

Meeting the maximum contribution limit on your 401(k) could be a good way to boost your retirement savings, especially if you've fallen behind. Before you direct your extra funds toward this goal, make sure you've paid off high-interest debt and can meet your current living expenses.