Maxing Out Your 401(k): Does It Pay?
Times are tight; jobs are fragile and many people are feeling the pinch. So it maximizing your contribution to your 401(k) plan might not be the first thing that comes to mind. However, for some people this is something that should definitely be considered. (Learn about the benefits and drawbacks of this new investment account in A Closer Look At The Roth 401(k).)
Putting the Option into Perspective
Start with the most important uses for your money.
1. Make sure your crucial bills - your mortgage, utilities etc. - are paid.
After all, a retirement account won't last if you have to raid it to pay monthly bills.
2. Contribute as much as needed to take the matching contribution in your 401(k) from your employer.
If 3% is matched, make sure you contribute 3%. This is a 100% increase on your money, risk free, and that's the best deal you're going to find.
3. Get rid of your credit card debt and other high interest debt.
This is the stopping point for many people. They just can't get out of credit card debt, and that's a killer for a long-term savings plan like a 401(k) because it doesn't do you any good to invest and try to get a 10% return, even tax deferred, if you are borrowing on a credit card at 24%.
4. Set up an emergency savings plan.
Even if you are paying your bills on time, contingency planning for major life events comes before long term retirement savings. Again, once deposited, retirement money needs to stay put.
But for those of you who are past those options and still have money, now there are some choices to make as to how to best handle the additional money and maxing out your 401(k) is a viable option. ("Spend now! Don't worry about retirement," say some experts. Could they possibly be right? Find out in Are You Saving Too Much?)
In Favor of 401(k) Contributions
1. Higher contribution limits than saving in a IRA or Roth IRA.
In 2009, the contribution limit for a 401(k) is $16,500, while an IRA is limited to $5,000. The catch-up provisions for those 50+ allow up to $22,000 and $6,000 respectively. The more you save now, the more you can have later.
2. Stocks are still well below historical lows.
So while there is no sure thing, there is wisdom in putting more money in when prices are off their highs.
3. This could be a one-time increase in your savings.
Because you can change your contribution next year, a large contribution when stocks are down might just be the shot in the arm your portfolio needs to either recoup recent losses or get started moving again. Even though timing the market is fraught with risk, this might be great opportunity to sock away some nest egg.
4. Reduced tax liability.
The IRA may not be tax deductible based on your income, and the Roth IRA isn't tax deductible.
Against 401(k) Contributions
1. Contributions are subject to penalty if you withdraw them.
So while it may seem like your situation is stable on the surface, be sure to dig deep to find out how secure you are financially. If you will need the money elsewhere, tying it up in a retirement plan will end up costing you.
2. 401(k) plans lack flexibility.
If you aren't going to go beyond the limits of the IRA and you can get the tax deduction, it's probably more advantageous to make the contributions there. Having control of the investment options is a big advantage to the investor. Even if you like the options in your 401(k) currently, they are out of your control and could change. The big advantage of the 401(k) is the higher contribution limit. If those don't apply, then the IRA is a very viable option.
If your financial house is still in order, there are good reasons why you should consider making the maximum contribution to your 401(k) this year. It might not be the first thing that comes to mind, but it deserves strong consideration.
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