4 Reasons Why You Shouldn’t Max Out Your 401(k)

The standard advice to maximize your 401(k) is excellent, but it doesn’t suit everyone all the time. There are a few reasons why contributing as much as you can to your retirement fund might not make sense, at least not some years. That’s because a traditional 401(k) locks your money away until you are 59 ½. Early withdrawal is allowed, but only in limited circumstances or with a tax penalty. It is not the only way to set aside money for retirement, either.

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1. You have high-interest debt

Early in your career, you might have high-cost debt to address. If you have high interest debt, such as credit cards or installment loans with interest rates above 15%, it may be best to concentrate on paying that off before contributing too much to your 401(k).

Also, if you are having trouble making the minimum payments on student loans or scramble to pay your rent every month, you may not have enough slack in your budget. Contributing to a retirement plan could actually hurt you in the near term. Look for ways to increase your income or reduce your spending before committing to long-term savings. Eventually, you should be able to afford to put enough money into your retirement to earn any employer match offered, then build to a full contribution.

2. You want to retire early

Some people want to retire before the age of 59 ½. If this is you, it’s a good idea to have money outside of traditional retirement accounts. For some, this will involve aggressive savings (the Financially Independent, Retired Early crowd). For others, it’s simply having money set aside for a year or two before traditional retirement accounts can be tapped. If early retirement is your goal, consider slowing down your 401(k) contributions once your account balance is adequate. It may be better to put your money in taxable accounts rather than pay the 10% penalty tax on early withdrawals.

3. You want to avoid huge required minimum distributions

Once you turn 72, the IRS requires you to take a minimum amount from IRA and 401(k) accounts. This required minimum distribution is based on the account value and your age. For most people, this is not a concern; they are more concerned about having enough money in their retirement accounts, not having too much.

A fortunate few find these required minimum withdrawals to be far larger than they want. If you have made maximum contributions for years, had success in the financial markets, and possibly have large deferred compensation funds in rollover IRA accounts that are included in the minimum distribution requirements, you may end up with ridiculously large RMDs and tax bills.

If you’re part of this minority of folks who may be forced to withdraw more money than they know what to do with, curtailing retirement contributions may be a good idea. You can put your savings into other investment vehicles, or consider giving it to charity to share your bounty.

4. You’re considering health care and long-term care

Many retirees have high health-care costs. Medicare is a pretty good deal, but it doesn’t cover everything. A health savings account is a tax-advantaged way to save for copayments, deductibles, vision care, and dental care. If you are eligible for a health savings account with your current health insurance, and if your retirement accounts are in good shape, consider maxing out your HSA contribution. The funds should roll over and be in place for you when you retire. The maximum HSA contribution for 2021 is $3600 for an individual and $7200 for a married couple filing jointly.

Long-term care is especially expensive, whether it involves help at home, assisted living, or a skilled nursing facility. Long-term care insurance is available and is relatively inexpensive the younger that you are. If your basic retirement needs are covered, buying a long-term care policy instead of making a 401(k) contribution may be a good bet.

By all means, maximize your 401(k) contribution if it makes sense, and participate just enough to get any employer match (free money!). But if you find yourself identifying with any of the points above, you may want to consider saving for retirement in a different way, at least for now.

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