When should I max out my 401k?
If you want to accumulate a big nest egg for your retirement, you should consider maxing out your 401(k) contributions. Find out when you should max out your 401(k).
If a 401(k) plan is your primary retirement savings plan, you should know when to make the most of your contributions. The best practice is to contribute at least the minimum to get your employer’s match. If you want to max out your 401(k), you should know the best time to increase your contributions.
You should max out your 401(k) when you can easily afford the contributions without causing a big impact on your budget. If you have high-interest debts, you should pay the debts to free up money that you can use to increase your 401(k) contributions. You should also create an emergency fund that you can tap into during emergencies instead of making premature 401(k) withdrawals that could reduce your retirement savings.
What does it mean to max out 401(k)?
Maxing out a 401(k) means contributing to a 401(k) up to the annual contribution limit determined by the IRS. In 2022, you can contribute a maximum of $20,500 to a 401(k), up from the 2021 limit of $19,500. Employees above 50 can contribute up to $27,000, including catch-up contributions.
If your employer matches 401(k) contributions, the matching contributions do not count in the annual IRS limits. However, the combined employer-employee contributions should not exceed a certain limit.
Cumulatively, the employer and employee contributions should not exceed $61,000 in 2022, or $67,500 if you are above age 50. For 2021, the combined employer-employee contribution limit is $58,000, or $64,500 if you are above 50.
When should you max out your 401(k)?
There are certain circumstances when maxing out your 401(k) may be considered a smart financial move. Here are situations when you can max out your 401(k):
You have an emergency fund
Save enough funds for emergencies before maxing out your 401(k). You should build an emergency fund that is enough to cover expenses for up to 6 months. These funds are easily accessible when you have an emergency, and you won't be forced to take an early withdrawal from a 401(k) to meet the immediate expenses.
You are financially stable
If you are struggling to pay bills, then it does not make sense to max out your contributions. Once you contribute to a 401(k), you should have enough money to make mortgage payments, education costs, groceries, transport costs, and utilities.
If you can pay your monthly expenses and still have extra money left, you can use the remaining funds to max out your 401(k).
You have paid off high-interest debt
If you have a credit card debt, car loan, or mortgage debt, you should compare the interest rate you are paying and the interest rate you are getting on 401(k) savings.
For example, if you are paying a 12% interest rate on a car loan, and the 401(k) earns an interest rate of 5%, it means you are paying more for the loan interest than the returns you get on 401(k) money.
Hence, it may be better to pay down the car loan before contributing to a 401(k) plan. Once all debts have been fully paid, you can use the free-up money to max out your 401(k) contributions.
You have achieved other financial goals
Instead of sacrificing your other financial goals for the sake of your retirement, you should plan to put at least enough money in your 401(k) to get the maximum 401(k) match and some money towards your other goals.
As you free up cash, you can adjust your 401(k) contribution to boost your savings. Also, as you approach retirement, you should find ways of boosting your savings without compromising your quality of life.
Should you max out your 401(k)?
The decision on whether or not to max out your 401(k) depends on your situation. While it may be desirable to set aside as much as possible for your retirement years, you should not neglect your other financial goals.
If you are a high-income earner, you may want to increase your contributions without impacting your budget. For example, if you earn at least $140,000, you can comfortably contribute up to $20,500 in 2022, and still have enough funds to meet your other financial goals.
However, if you have a limited income, maxing out your 401(k) may not make sense. You can still build an adequate nest egg at your income level without contributing up to the IRS limit.
For example, if your annual income is $50,000, it would be impractical to contribute up to $20,500 since you may be unable to meet other financial goals. In this case, you can contribute at least the minimum amount required to capture your employer’s 401(k) match.