Should I Max Out My 401K…
Should I Max Out My 401K… Read This Before You Become a Retirement Hero
Contributing to a 401K is like flossing. It’s only fleetingly satisfying. And in both cases, some gray-haired dude wielding a pointy stick is telling you that if you do it every day you’ll be much happier in several decades and you just smile and nod and pretend you understand. If you’re sitting there wondering, "Should I max out my 401K?"—you’ve come to the right place. We’re going to floss our way through this quickly. I’m going to stay away from scary math.
What Does it Mean to Max Out a 401K?
To answer the question “should I max out my 401K” we need to first consider the meaning of “max out my 401K.” There is the technical (IRS-imposed) limit to maxing out a 401K, and then there is the practice of maxing out your contribution that is matched by your employer.
So, maxing out your 401(k) in 2024 means throwing $23,000 into the ring if you're under 50, or $30,500 if you're in that sweet over-50 club with the catch-up contributions. This holds whether you’re contributing to an employee-sponsored or solo 401K. For the self-employed, you can also contribute above the annual maximum in the form of company profits (up to 25% of profits, up to $69K as of 2024).
To recap: the major benefit of a 401K plan (whether solo or employee-sponsored) is that you are not taxed on your contributions in that year. So if you were to make $123,000 per year and contribute your annual maximum of $23K, you would be taxed on $100K of income (pending any other deductions). This benefit is a tax deferral; it does not mean your contributions were tax free. In other words you still have to pay tax on your withdrawals once you reach retirement. However you have the benefits of
Being able to “time” your withdrawals in a tax-efficient manner
Withdraw at a time when your overall tax burden is lower (because you are earning less)
Benefitting from the “time value of money” principle — the extra cash you pocket today can be invested elsewhere, helping you earn more on a time-weighted basis throughout your career.
The key thing: when most people consider “should I max out my 401K” they are talking about maxing out their contribution to the employee match. Many employers will “match” your contributions into your 401K. In the most generous cases, this might be up to 6% of your salary. The average 401k match is typically in the 4-6% range, with 98% of employers who do offer a 401k offering at least a partial match. So to cut to the chase here: if your employer offers a 401k match, you should definitely max out up to that match threshold. If your employer matches up to 5%, you should contribute 5%. This is free money! If you make $100K a year, say, and your employer offers a 5% match, that means that by contributing 5% to your 401K, not only will you be reducing your tax basis by $5K per year, you will be gifted $5,000 extra by your employer. So effectively you made $105K but were taxed only $95K.
That said, let’s take a look at some other dimensions to the “should I max out my 401K” question.
Pros of Maxing Out Your 401K
Tax Savings—AKA the Government’s Least Horrible Gift
Again, by putting money into your 401(k), you can lower your taxable income for the year. That means you’ll owe less in taxes now, which leaves more cash in your pocket today. So, yes, in a world full of bad news, this is the closest we get to the joyless bureaucrats at the IRS. Have you ever talked to their customer service people? HO-LY. Shit. They’re just people trying to do a job, I guess.
Anyway, setting aside employee matching, this means that you can avoid paying taxes on up to $23K of your annual income. If you can afford it, this may be quite the benefit.
Compound Interest—Or How You Become Rich While Doing Nothing
Returning to our flossing analogy, this is where the long view really comes into play. Maxing out your 401K brings benefits that are like the inverse of gum surgery. It might be a long ways away but it’s a big deal. Building a substantial 401K nest egg early in your career can have an outsized effect. If you are able to max out your 401k throughout your twenties and thirties, the average upward performance of public assets should push your retirement portfolio to impressive heights.
The main consideration here: does your life facilitate this? If you have kids and a mortgage, this probably does not make sense — you will need that extra cash. If you have a kid and could still afford to max out your 401K, you probably want to consider a 529 plan as an alternative, which offers additional tax benefits.
I have no reason to put this here, but it’s mesmerizing … this would be a cooler way to get rich.
Cons of Maxing Out Your 401(k) (Because There’s Always a Catch)
It’s America and this is late-capitalism. If there was a “retire easily” button, someone would have privatized it and squeezed all margin out, to your detriment. I guess this is sorta the essence of the 401K. Anyway, here are some reasons you may not want to max out your 401K.
Goodbye, Liquidity
Once your cash is in a 401(k), it’s in there until you’re 59½, unless you want to pay hefty penalties to get it out early. So, if you max it out and your car suddenly decides to impersonate a toaster, you might find yourself literally out of gas.Fees n’ shit…
As Jack Bogle pointed out, fees are what make the true difference in most investor’s portfolios over the long term. While it’s hard to beat the market, a difference in fee load by a fraction of a percent is magnified over decades. Some 401Ks come with high fees that can quietly eat into your returns like a small school of investment piranhas. If your plan’s fees are high, it might be better to max out at a lower level and use other investment vehicles for the rest. This is why it’s probably a good idea to check out your employer’s 401K administrator and not blindly accept it as your best investment channel. Again, if your employer offers matching, take all the damn matching you can get. But otherwise, compare that fee load to what you might get from another roboadvisor or an IRA, because from an asset perspective you’re generally buying the same shit.Other Investment Opportunities Might Be Way Cooler
Sure, a 401(k) is great, but let’s not pretend it’s the only game in town. You might be missing out on other cool investments like a Roth IRA, real estate, or that artisanal kombucha side hustle you've been thinking about.
More on that last point: diversification beyond stocks and bonds is probably a good idea. Markets ebb and flow but more tangible assets (like private-market real estate which you can get at via platforms like EquityMultiple or Fundrise) can give you returns that are less correlated, which can help to reduce risk over the long haul.
As investing thinkers like Financial Samurai point out, cash flow is really key to achieving early retirement. Basically you grow and reinvest your cash flows from non-tax-advantaged assets (like real estate) and you build passive income streams until you achieve “escape velocity,” covering your cost of living and continuing to magnify returns over time. 401Ks are quite the opposite: while your investments may compound, you can’t pull money out without paying a penalty until you’re 59.
For these reasons you probably shouldn’t max out your 401k (beyond the employer match) unless you’re absolutely swimming in income. You’ll want to diversify your current investing prospects in the interest of diversified return profiles and near-term cash flow.
Are 401(k)s ESG-Friendly? Time to Talk Ethics
Should I max out my 401k from a socially responsible investing standpoint? If your retirement strategy involves more than just making sure you have enough money to cover your future yoga habit, you might be wondering if your 401(k) is as ethical as your bamboo toothbrush.
Spoiler alert: most 401(k) plans don’t exactly scream “save the whales.” In fact, they’re often full of investments in oil, gas, guns, cigarettes, and other companies that might make you want to hug a tree just to balance out the bad karma. But if you care about Environmental, Social, and Governance (ESG) factors, there are a few ways to green up your retirement savings:
ESG Funds—They Do Exist!
Some 401(k) plans offer ESG-friendly funds, so you can sleep easy knowing your money is going toward renewable energy or companies that aren’t actively trying to destroy the planet. If you don’t see any options in your plan, don’t be afraid to ask your HR department why—after all, you’re the one trying to retire and not retire into a post-atmospheric hellscape. Another reason to drill into the admin your employer has picked.Supplement with Other ESG Investments
If your 401(k) options are as morally questionable as a puppy mill, consider putting some of your savings into an ESG-focused IRA or a taxable brokerage account. That way, you can still get your employer’s 401(k) match without feeling like you’ve funded the next oil spill.Consider a Self-Directed 401(k)
Feeling extra savvy? You could look into a self-directed 401(k), which gives you more control over where your money goes. It’s like getting to pick your own adventure—except the treasure at the end is a comfortable retirement instead of, you know, pirate gold.
So, Should You Max Out Your 401K?
The answer? Maybe. Maxing out your 401(k) is a solid way to lock in tax savings, take advantage of free money, and grow your retirement savings without lifting a finger (literally, compound interest does all the heavy lifting). But make sure it’s the right move for your situation.
Consider your need for liquidity, your investment options, and whether you care about saving the planet along with saving for your retirement years. And remember, there’s no retirement rule that says you have to max out your 401K to be financially responsible. Just like there’s no rule saying you can’t have pizza for breakfast on a Tuesday.
In conclusion, should you max out your 401K…
To your employer match (if your employer does offer a match)... yes, all day every day.
… beyond that, probably not unless you’re young AND not cost-burdened AND making enough to properly diversify your portfolio AND you feel OK about the fee load and investment strategy of the 401K plan admin.
If you have other thoughts on whether one should max out, please let us know!