When thinking about retirement, no matter your age, you probably wonder if there’s enough in your 401(k) to sustain your post-work years. At that moment, you may be motivated to begin maxing out your workplace retirement account—helping to ensure that you can live your dream retirement without financial worry. But, is it a good idea to start placing that much of your income into your 401(k) right now? Let’s take a look at what you should consider first.
What is considered “maxing out” your 401(k)?
As of 2020, the maximum annual contribution to your 401(k) sits at $19,500, unless you are 50 or older, in which case your maximum amount is $26,000. If you were to contribute that amount, you would be “maxing out” your 401(k).
5 Things to Do Before You Begin Maxing Out Your Annual 401(k) Contribution
1. Pay Off Debt
Before you begin maxing out your 401(k), you may consider paying off your high-interest debt. In particular, credit cards tend to have high interest rates, costing you interest and ultimately having a counterproductive effect on your financial strategy.
2. Have an Emergency Fund
It is essential to have an emergency fund with three to six months of living expenses. This fund will help to keep you out of debt when the unexpected comes up, and give you the confidence that the money you’re putting toward your 401(k) wasn’t needed elsewhere.
3. Purchase Life and Disability Insurance
Though life and disability insurance aren’t typically large expenses, they would take priority as they will help protect you and your family from financial burdens. You can rest assured knowing that your family is taken care of if you were to pass away. It’s also essential that you know that if you were to be injured and unable to work for a long period of time that your living expenses would be covered.
4. Save for Big Purchases
Are you saving for a big purchase like a car or house? Rather than putting that money toward your 401(k), it may serve you better for your next big-ticket item. In addition, you would take on less debt with more money in your savings, leaving you in a better position to contribute to your 401(k) later.
5. Contribute to Your HSA
Your health savings account is an excellent way to save money while receiving great tax benefits: deductions, tax-deferred growth, and tax-free distributions. As of 2020, individuals can contribute $3,550, and families can contribute $7,100 to their HSA annually.
Why should you max out your 401(k) (if you’re financially ready)?
Once you have considered other pressing financial responsibilities, maxing out your 401(k) is a good financial strategy. Contributing to your 401(k) offers tax benefits, gives your money more time to gain compound interest, and makes you feel more confident.
Mistakes to Avoid When Considering 401(k) Contributions
Missing Out on Employer Contributions
Consider that if you max out your 401(k) too early, you may miss out on employer contributions, as the maximum contribution also applies there. For example, if you hit your $19,500 contribution limit, you will not receive a company match for the rest of the year.
Losing Potential Profit
If your 401(k) plan is not ideal, your money may work harder for you in a different account. Ensure that you get the maximum amount of your employer matching contribution, and then consult your financial advisor on where to put your money after meeting that percentage.
Putting Off Other Financial Responsibilities
Saving for retirement is essential; however, it’s important that you meet your other, potentially more pressing, financial responsibilities prior to maxing out your 401(k). Everyone’s financial situation is different—consider reaching out to your financial advisor to discuss a long-term retirement strategy.
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