Should You Max Out Your 401(k)?

We all know that person who does everything to the max. Whenever he goes to a restaurant, he’s ordering the most expensive item on the menu. If she’s going on vacation, she’s booking the fanciest hotel she can find. There’s no going halfway!

What if you took that all-in approach to your retirement savings? Is it worth it or even realistic to max out your 401(k) each year?

The truth is, maxing out contributions to a 401(k) plan isn’t the right choice for everyone. But if you’re at a certain point in your financial journey where you can invest more money toward your retirement future, it could be a game changer. 

How Does a 401(k) Work?

Okay, here’s a quick refresher: 401(k)s are employer-sponsored retirement plans that make it easier for employees to save for retirement. They’re a great way to save for retirement because they come with special tax advantages and most employers offer a company match on your contributions (which is free money).

Generally, there are two types of 401(k) plans out there: traditional and Roth.  

Traditional 401(k)

When you put money in a traditional 401(k), those contributions lower your taxable income for the year—which means you’ll pay less in taxes this year. But there’s a catch: You’ll have to pay taxes on your withdrawals when you take your money out in retirement. Basically, you’re kicking your tax bill down the road.   

Roth 401(k)

Roth 401(k)s are a different beast altogether—when it comes to taxes anyway.  You won’t get a tax break on your contributions to the account because you’re funding the account with after-tax dollars, which means the money that goes in has already been taxed.

But then you get something more valuable in return. Your investments grow tax-free and you won’t pay any taxes on your withdrawals in retirement.

(Side note: If you have a company match, your employer’s contributions go into a separate pretax account. That means you’ll pay taxes on the money and its growth when you take the money out in retirement. If you want tax-free growth and withdrawals on that money too, you’ll need to do an in-plan Roth rollover each year and pay taxes on whatever amount you transfer.)     

How Much Would It Take to Max Out My 401(k)?

For 2023, you can invest up to $22,500 into your workplace retirement plan (and an extra $7,500 if you’re over 50 years old and need to play catch-up).¹ That means you need to contribute $1,875 from your paychecks each month to max out your 401(k).

If that sounds like a lot, that’s because it is a lot! Let’s be clear: You don’t have to max out your 401(k) to build a solid nest egg. Let’s talk a little bit more about when it makes sense to max out your 401(k) . . . and when it doesn’t.

What Are the Benefits of Maxing Out My 401(k)?

Maxing out your 401(k) has some pretty clear benefits—especially if you want to grow your nest egg faster or if you’ve fallen behind on your retirement savings goals.

You’ll Have More Money Saved for Retirement

More than anything else, studies have shown that the greatest indicator of retirement success is your savings rate.² Translation? You’ve got to save money for retirement to have money for retirement. And the more you save, the more likely you are to have enough money to retire with dignity and even leave a lasting legacy for your family.

That means maxing out your 401(k) contributions is a Shaquille O’Neal-level slam dunk that can help you build a massive nest egg over time.   

Your Retirement Savings Will Grow Faster

Investors love talking about compound interest, which is basically the money your money makes when you invest it. And when you max out your 401(k), you’re basically pouring gasoline on a potential explosion of compound growth for your investments.

How much will you need for retirement? Find out with this free tool!

Assuming the stock market’s average annual rate of return (11%), you could have more than $5 million in your 401(k) if you max out your contributions every year from age 30 to 60.³ And the vast majority of that money ($4.5 million) is all compound growth. Boom! 

You’ll Enjoy More Tax Benefits

If you have a traditional 401(k) at work, the money you put into your 401(k) lowers how much you’ll pay in taxes for the year and potentially puts you in a lower tax bracket. Plus, the investments in your 401(k) will grow tax-deferred, so you won't pay taxes on them until you withdraw the funds in retirement.

What if you max out a Roth 401(k) instead? In that case, all the money you contribute gets to grow tax-free and you won’t pay any taxes on your withdrawals in retirement.

You’ll set yourself up for a great retirement with either option. But if you have the choice between a traditional or Roth 401(k)—we’ll tell you to go with the Roth every time. Because those tax-free withdrawals mean your retirement savings will go even further!

In fact, here’s how we recommend you split up your retirement investing based on the type of 401(k) you have:

1. Traditional 401(k): Invest up to the employer match. Then max out a Roth IRA. Your first goal is to invest 15% of your income. If you haven’t reached your 15% yet, bump up your contributions in your 401(k) until you do.
2. Roth 401(k): If your plan offers good growth stock mutual fund options, you can invest your entire 15% in your employer plan. If your options aren’t great, follow the same steps above.

Now, when you’re ready to max out your 401(k) (and we’ll talk about the best time to do that next), you’ll just increase your contributions until you reach that $1,875 goal.

When Does It Make Sense to Max Out Your 401(k)?

There’s a time and a place for everything—and that applies to maxing out your 401(k) too. Based on Ramsey’s 7 Baby Steps—the financial plan that’s helped millions of families get out of debt and build real wealth—there are three scenarios where it makes sense to contribute all you can to your workplace retirement plan. Let’s walk through each one together: 

1. You’re Completely Debt-Free

No matter how gung ho you are about investing for retirement, wait to max out your 401(k) until you’re completely out of debt—which means you have zero consumer debt and a paid-for house (that’s what we call Baby Step 7).

When you don’t have any debt payments or mortgage payments, that’s hundreds (or even thousands) of your hard-earned dollars freed up for investing. At that point, you can use more of your income than ever before to max out all your retirement plans, pile up cash, and be outrageously generous.

2. You’re a High-Income Earner

The more money you make, the more you can invest in your 401(k). Pretty straightforward, right?

We recommend investing 15% of your gross income to save for retirement (that’s Baby Step 4, by the way). So if you’re 100% debt free and have an annual salary of $150,000 or more, you could max out your 401(k) simply by investing your entire 15% through your workplace retirement plan.

And like we mentioned earlier, don’t forget to take advantage of an individual retirement account (IRA) in addition to your 401(k)! If you’re a high-income earner, chances are, you won’t be able to contribute to a Roth IRA because of the IRS income limits on those accounts. But you could still invest with a traditional IRA, which has no income limits.

Then you have the option to move the money from your traditional IRA into a Roth IRA with backdoor Roth IRA (and don’t worry, it’s completely legal).       

3. You Need to Catch Up on Your Retirement Savings

According to The State of Personal Finance study, more than half of Americans (60%) feel like they’re behind on their retirement savings goals. If that’s you, there’s still time to get back in the game!

Again, as long as you’re completely debt-free (including no house payment) and have a fully funded emergency fund, you should throw as much money toward retirement savings as you can. Look for expenses you can cut from your budget or opportunities to boost your income so you can get there faster.

The more money you can invest in your 401(k), the faster you can catch up on your retirement savings.  

When Should You Avoid Maxing Out Your 401(k)?

Maxing out your 401(k) is a good goal. But it’s very possible that now isn’t the right time for you.

1. You’re Still Getting Out of Debt

Your income is your most powerful wealth-building tool. And you can’t fully unlock your income’s wealth-building potential if you still have credit cards, student loans and car loans lying around. That’s why your first priority is to get out of debt—fast!

At this point, don’t even think about maxing out your 401(k). In fact, stop all your investing until you get debt out of your life for good. Use the debt snowball method to pay off your debts from smallest to largest. That’s your main focus right now.

2. You Don’t Have Money Saved for Emergencies

When you don’t have enough cash on hand, even the smallest emergency can turn into a major crisis. And as a result, some folks resort to taking money from their 401(k)s to cover the costs.

Last year, a record number of Americans raided their 401(k) plans for hardship withdrawals, which allows people who are short on cash to take money out of their retirement plans to handle certain kinds of emergencies—think medical care expenses or payments to avoid eviction.⁴

Taking money out of your 401(k) is a massive mistake. Not only will you pay whatever taxes and penalties you owe on the funds you withdraw, but you’re potentially sacrificing hundreds of thousands of dollars of future growth in the process.    

Don’t put yourself in that situation! Before you invest, get a fully funded emergency fund in place—that’s 3–6 months of expenses stashed in a high-yield savings account or money market account. That way, you won’t have to sacrifice your future to keep you afloat in the present when a real emergency pops up. 

3. You’re Saving for Other Financial Goals

If you decide to max out your 401(k), you’re making a choice not to use that money until you retire. Because if you take money out before age 59 1/2, you’ll have to pay early withdrawal penalties and any taxes you owe on the money you take out.⁵ Your 401(k) is your nest egg, not a piggy bank!  

That’s why we recommend saving 15% for retirement when you’re ready to start investing—because you need to keep some room in your budget for other important financial goals, like saving for your kids’ college funds (Baby Step 5) and paying off your house early (Baby Step 6).

Once there’s enough money set aside for Junior’s college education and you send your last mortgage payment to the bank, then you can start thinking about maxing out your 401(k).

Talk With an Investment Pro

If you’re still thinking about maxing out your 401(k) and have questions about the impact it’ll have on your finances, nest egg and tax situation, talk things over with your financial advisor or investment professional.

Don’t have one? The SmartVestor program can connect you with up to five investment pros in your area who are ready to help you go over all your options.

Find your SmartVestor Pro today!