A 401(k) plan is a powerful tool to save for retirement. If your employer provides this option, or an employer-sponsored retirement plan similar to it such as a 403(b) or 457 plan, we recommend taking full advantage of the employer match. 

It’s also important to contribute an appropriate amount to your 401(k) each paycheck to ensure that your retirement is financially comfortable and taking advantage of the employer match is one of the best ways to ensure that.  There are also specific tax benefits when contributing to or withdrawing from your plan, depending on which style you choose, Roth or Traditional.

Maxing out a 401(k) can help you get the most out of your retirement savings strategy, but it may not always be the right choice for your financial situation at the time. In this article, we’ll talk about how to max out your retirement plan and whether it’s the right decision.

What Does Maxing Out Your 401(k) Mean?

Maxing out your 401(k) means contributing the maximum allowed limit in any given year, as per the 401(k) annual contribution limits.

For example, the maximum employee contribution limit for 2023 is $22,500. There is a special catch-up contribution limit that allows you to contribute an additional $7,500 if you’re  age 50 or older, for a total of $30,000. To max out your account, these are the respective amounts you’ll need to invest this year.

Is It Good to Max Out Your 401(k)?

Saving for retirement is important, and maxing out your 401(k) is generally a good thing if you’re also meeting your other financial goals. We recommend that you take stock of your other financial obligations and goals and seek-out financial planning advice from an experienced, licensed professional, before you do.

“It is always a good idea to contribute as much as you can to your retirement accounts and invest the funds properly, according to your goals and tolerance for risk,” encourages Brad Reichert, financial expert and founder and managing director of Reichert Asset Management.

“However, it’s important to make sure your basic liquidity needs are covered first, in addition to paying off as much of your high-interest debts as possible,” Reichert adds. 

Consider meeting these financial goals before you increase your contributions to max out your 401(k):

  • Pay off credit card debt and other high-interest debt, because these types of unsecured debt often cost you significantly more in interest and fees than what you would earn on your investments inside your 401(k) account.
  • Put aside an adequate emergency fund, ideally in a high-yield savings account, that is equal to at least 3 months’ worth of your normal living expenses, to deal with job loss or unexpected expenses.
  • Make sure you have enough room in your budget for all your expenses and bills.
  • Create a sinking fund and save for large expenses such as a planned vacation or home renovations.

Pros

  • Maxing out a traditional pre-tax 401(k) reduces your taxable income, so you’ll pay less in personal income taxes.
  • It helps you save money for retirement, on a tax-deferred basis.
  • You may be able to retire sooner if you consistently max out your account each year.
  • Investing more, early on, will allow you to take advantage of the compounding of your investment returns over the years.

Cons

  • Your money will be effectively “locked up” once it’s in your retirement account, unless you’re willing to pay early withdrawal penalties, if you’re under 59-½, as well as potential income taxes on any money you take out, regardless of your age.
  • You may not have enough liquid assets on hand to deal with unexpected expenses.
  • There may be an investment account with fewer penalties and/or income taxes when accessing your invested funds, when you might need them in an emergency.
  • You may not have enough money to pay off high-interest debt.

Tax Benefits of Maxing Out Your 401(k)

The money you contribute to a traditional pre-tax 401(k) plan will be deductible against your Adjusted Gross Income (your AGI), and if your contributions are large enough, may help to put you in a lower marginal income tax bracket. 

Your investments in this type of retirement account also grow tax-deferred, which means that you will not have to pay income taxes on any interest, dividends, or capital gains, no matter how much you earn during the year.  

You’ll only pay taxes when you withdraw the money from your 401(k) account, while you’re in retirement. Maxing out your 401(k) will also help you gain the most advantage by lowering your taxable income on a dollar-for-dollar basis.

If you have a Roth 401(k) plan, your contributions are made with after-tax income. However, your money will grow tax-free, the same as in a pre-tax 401(k) account, but with a Roth 401(k) account, you won’t have to pay any taxes when you start taking withdrawals in retirement, assuming you start taking them after age 59-½ . 

Maxing out your Roth 401(k) will help you make your retirement savings go further, because you will not have to pay income taxes on any withdrawals you take from it, in your retirement years.  

6 Steps To Maxing Out Your 401(k)

If you’re on track with your other financial goals and want to max out your retirement savings, here are a few strategies to consider.

1. Max Out Employer Contributions

If your employer offers matching contributions, we recommend taking full advantage of this free money. Check your employer’s rules and contribution limits for details on their formula for crediting your 401(k) with their matching contributions. Some employers may require a predetermined minimum contribution (such as 4% or more of salary) from an employee before they’ll deposit the full matching contribution to your account.

We recommend contributing enough money each paycheck to get the maximum allowable employer match. For example, if your employer matches 50% of your contribution (aka your salary deferral %), to a maximum of 3% of your salary, you should contribute at least 6% of your salary each paycheck, in order to get the full matching contribution from your employer.

2. Max Out Your Salary-Deferred Contributions

Salary deferral means setting aside as much as your budget allows and deferring it each pay period, until your retirement. If you have any extra money after  contributing at least up to the employer match, consider deferring a higher percentage of your salary, to lower your taxable income and increase your retirement savings.

3. Use Catch-Up Contributions to Put Aside More

If you’re over the age of 50, the IRS allows you to contribute an extra amount, to “catch-up” on your contributions in the years immediately leading up to your retirement. As you get closer to retiring, these extra contributions can make a difference by lowering your taxable income further and helping you save more, if you don’t have a sufficient amount saved to meet your retirement income goals.

4. Put Aside Bonuses for Retirement

In many cases, your employer will allow you to determine how much money you can contribute to your retirement plan from your bonus check. Consider putting aside a major portion of your bonuses to your retirement funds to help you max out your 401(k).

5. Change Your Automatic Contributions

Your 401(k) contributions, once you elect your percent of salary deferral, are automatically deposited in your retirement account. Review and change them periodically to ensure you’re putting aside enough to max out your account, based on your salary. For example, to max out your account in 2023, you’ll need to put aside $1,875 each month.

6. Avoid Tapping Into Retirement Funds

Avoid making 401(k) hardship withdrawals or taking out a loan against your account. If you withdraw early, you may have to pay taxes, plus a 10% early withdrawal penalty if you’re under 59-1/2. This can lower your savings balance and make it much harder to catch up later.

What To Do After Maxing Out a 401(k)

After maxing out your 401(k), consider taking advantage of other tax-advantaged accounts or boost your emergency fund. Here are a few options to consider:

  • Consider contributing to an individual retirement account (IRA). Similar to your 401(k) account, there are different tax benefits from each type–traditional pre-tax IRAs or Roth IRAs.  Contributions are made with pre-tax dollars to a Traditional IRA, and withdrawals are fully taxable in retirement.  Contributions are made to a Roth IRA with after-tax dollars, but you’ll be able to take tax-free withdrawals once you turn 59-½ and it has been at least 5 years since you made your first Roth IRA contribution.  
  • Invest in a health savings account (HSA). You get a tax deduction on your contribution, your investments will grow tax-free in the account, and your withdrawals for qualified medical expenses are also tax-free.
  • Put aside more money in your emergency fund as your living expenses increase.
  • Open a 529 college savings plan to set aside money for education costs for your children.  The contribution limits for these accounts are usually $250,000 or more, depending on the state you’re in, with no annual contribution limits, beyond the total limit per account.
  • Open a brokerage account to invest any extra money. There are no contribution limits with this investment account, but you’ll pay  income tax when you earn interest and dividends, or when you sell investments for a profit.

Is It Worth Maxing Out a 401(k)?

Maxing out your 401(k) plan is a good way to save on taxes and meet your retirement savings goals. However, if you have other financial obligations, such as paying high-interest debt or starting an emergency fund, we recommend taking care of those, as a priority, while contributing enough to get the company’s match.

Once you’ve taken care of those, you can start maxing out your 401(k) and consider other tax-advantaged accounts. We also recommend speaking to an experienced, licensed financial advisor about which investment options can help you achieve your financial goals.