What to know maxing out your 401(k)?

Max out 401k

If you are on a 401(k) retirement plan, you are on point. You are one of the few who have taken steps on preparing for retirement. According to a report released by Statista, in September 2019, more than half of the European adult population does not have a retirement plan.

That is staggering. Unfortunately, this statistic includes adults close to retirement age. New School's Schwartz Center for Economic Policy Analysis, specifically reported that 35% of all workers ages 55 to 64 have no retirement savings.

Thus, you deserve some accolades if you are on a retirement plan, especially 401(k).

But the question is: “Should you max out your 401(k)?”

Forget the myths you have heard from some people about the ills of maxing out your 401(k) contribution annually.

Maxing out your plan is, indeed, a great decision to make. IRA has announced that for 2020, one is allowed to max out a total of $19,500 as an annual contribution.

If one is above 50, he is permitted to add a catch-up of $6500, bringing the total to $26,000 in a year. If you've got the chance, don't hesitate to consider a maximum contribution. I know you shouldn’t just take my words for it.

So, check out the impressive benefits you stand to gain should you decide to max out.

What are the benefits of maxing out your 401(k)?

1. Steady Steps to Millions

Yes, maxing out is one of the surest ways to become a millionaire in this day and age. It may take a while, say a couple of years. Nevertheless, the path is stable, and you will get there, especially if you start young.

2. Exponential Growth

Well, even if you do not hit the millions, maxing out your plan still guarantees you a tremendous growth rate on your contributions.

So, why not max out?

Without a doubt, the more money you put into your 401(k) at any given point in time, the more you'll have by the time you're ready to retire.

Take a look at the following analogy: A man decides to max out his annual contribution ($19,500) at age 25. By the time he is 65, the money would have become $292,000 if the annual return on the funds is 7% (and usually it’s more than 7%).

If the same man maxes out his contribution ($19,500) at age 35, by the time he is 65, the money would have become $208,000, at a 7% annual return.

The list is fantastic!

3. Retirement Plan’s Shield

Maxing out often protects your retirement plan, in case of a financial setback. Take, for instance, a year may arrive that you could barely contribute to your 401(k) plan (perhaps due to loss of a job, or ill health, unforeseen hazard, etc.).

Your previous maximum contributions will cushion the effect on your plan. In other words, your retirement plan will not feel the setback (for a year, or more), till you are restored, depending on the maximum contributions you’ve made hitherto.

4. Financial Discipline

Deciding to max out, even for just a year, can be a tough call. It requires much discipline and sacrifice.

Thus, the decision will strengthen your financial muscles. Just think about it, if you're able to pull off that achievement one year, you might manage to do so a second year, and another one after that.

That way, your financial discipline is enhanced. And that'll put your retirement savings in great shape.

So, as you can see, if you get the right chance to max out, whether for a year, two years, or perpetually, take it!

Now, wait a minute! Note those three words carefully: the right chance. That means there is a right time to max out, and there is a wrong time. The question, at this juncture, isn’t whether I should max out or not.

We answered that already: you should. The issue here is when should I max out, and when should I not? A coin always has two sides.

When Should You Max out Your 401(k) Contribution?

As we have seen, a maximum annual contribution to your 401(k) retirement plan is a laudable decision. However, there is a right time for every good thing, just like every crop has its planting season.

For you to know when you should max out, there are two main factors that you must consider. There may be other factors. Notwithstanding, these two cannot be overemphasized.

1. A Good Financial Condition

Maxing out isn’t a red rose that you blindly charge at without thoughts. You must consider your financial position.

You must be in great financial condition before you consider maxing out.

Now, an excellent financial condition implies that most, if not all, of your non-retirement goals, have been met. Of what benefit is it, if you have money stashed away in your savings, and you are wearing away under the weight of immediate responsibilities?

What does it profit to prepare for a future that one wouldn't see because of the starvation of today?

2. High Quality of Employer-Sponsored Retirement Plan

Even if you are in a perfect financial condition, check out the quality of your employer's retirement plans. You must be aware that different companies follow different schedules for their employees’ retirement plans. Some are shrewd, and some just are not.

So, meet with the HR of your firm. Ask questions.

You don’t want to back the wrong horse. Ensure that your employer’s plans and investments are high in quality. What you are looking out for is that your company invests in some of the best opportunities available at the lowest possible risk.

3. Your Age

Well, if you are still young, there isn't much pressure on you to max out. That does not nullify the fact that time is one of the greatest allies of retirement plans. The younger you are, the more the compounding you enjoy over time.

Still, there is no pressure. However, if you are older and closer to retirement, maxing out your annual contribution (including the catch-up) graduates from the level of advice to imperative.

Maxing out more likely becomes the primary way to go for you.

When You Shouldn’t Max out Your 401(k) Contribution?

You now know that maxing out your 401(k) plan is the best decision; until it is not. You now also know when you should max out. Let’s consider the flip side of the coin.

In other words, when shouldn’t you attempt to max out your 401(k) contribution?

Well, there are specific things to watch out for again, which signal that maxing out isn’t ideal at the time. These are provided here.

1. Your Annual Income

One of the things to consider before you max out your annual contribution is your income. Well, the higher your income, the higher the chances of maxing out your contribution. But not everybody is in a position to contribute $19,500 per annum.

Take, for example, your annual earnings sum up to $45,000 or $50,000. Contributing one-third of your income is definitely not the way to go, as it may jeopardize your regular expenses.

2. Your Non-Retirement Goals

One thing is sure. Once your money has gone into retirement savings, you cannot easily retrieve it without penalties – unless you turn 59 and a half years.

Thus, it is not advisable to max out your contribution if you have not met your current needs, or if your financial state is at a low ebb. According to financial experts, there are several goals you must match before committing to the maximum contribution.

If you have high-interest credit card debt, personal loans, car loans, etc. Remember, mortgages can be costly.

If you cannot cover your shorter-term financial life goals such as having a child, buying a home, or another major purchase.

If you do not have at least three to six months of necessary living expenses set aside in an emergency fund.

If you do not have adequate life insurance coverage.

3. Charges & Risks

This is not often mentioned, but it is crucial. If your 401(k) plan is laden with high fees or if the retirement plan does not have a good investment with a great prospect, it may not be the best option to max out your contribution.

Merely matching your employer's input to the plan may suffice here. If you must give a maximum contribution, consider moving your investment over to funds with lower fees first. Otherwise, as money comes in one way, it goes out the other way.

How Quickly Should You Max Out?

There is one more essential factor you should consider before you decide to max out your contribution. That is the timing of your maximum contribution for the year. You will recollect that, up to a limit, your employer also contributes to your 401(k) plan in direct proportion to your savings.

Your company may be on a match schedule for a full year. This implies that they plan to match your 401(k) contribution every pay period.

Now, suppose you got a massive amount of money. And suppose you decided to max out your contribution too early or by the middle of the year, you could miss out on your company-match contributions for the rest of the year.

Hey! Your company’s match is one of the most important benefits of your plan. You should never do anything to make you lose free money, and that’s a lot of free money you will lose, depending on how early you max out your contribution.

Of course, you can prevent this by making sure you don't reach $19,500 in contribution before your final paycheck for the year.

Another form of prevention is what is known as true-up. True-up is a feature on 401(k) that guarantees employees will benefit from the max amount of employer-matched funds the plan allows.

If you are lucky that true-up features in your company's 401(k) retirement plan, then deferment of maxing out is unnecessary. Instead, it comes with its benefits.