Maxing out 401(k) contributions
Q. - I’m far behind in saving for retirement. Should I be maxing out my 401(k) contribution?
A. - This is a Yes/No answer. Yes, you should maximize what you can save for retirement, but no, not in a 401(k). There are multiple reasons: taxes, liquidity, investment options, fees, and rules. Simply put, if you put everything in the 401(k), you’re bound by the investment options and rules for the 401(k) you’re given and can’t change those constraints without taxes or penalties later.
An employer may match a few percent of your 401(k) contribution, so you definitely want to contribute enough to get the full match. After that, there are better options for additional retirement savings. First, let’s review the downsides of a 401(k) account. A 401(k) is administered by a financial service provider chosen by your employer, which offers a limited number of investment options for 401(k) participants, some of which may have above-average expenses. There may be an annual account fee for recordkeeping, and there are penalties if you take money out before age 59½ (unless it’s from your last employer's 401(k), in which case you can start taking money from the account after age 55). While hardship withdrawals and loans may be allowed, they are subject to rules and a process to follow. Thus, the 401(k) as a retirement savings vehicle is an okay option if offered by your employer, but it has restrictions and limitations.
Next is the issue of tax deferral. You save on taxes now when you put the money into the account, but pay taxes later in retirement when you take it out, and the money is taxed as income. However, starting at age 73 (currently), you must take out a minimum amount, called the Required Minimum Distribution (RMD), and pay taxes on that amount, whether you need the money or not. The minimum amount increases every year as you get older. So, when someone decides to max out a 401(k) contribution, currently $24,500 in 2026 (over age 50 can save $8,000 more), and does that for many years, they’re just creating a tax bomb in the future due to the investment growth of the 401(k) yielding a much higher balance to be taxed later. This situation then leaves some to take action to minimize the problem - before or after retirement - attempting to get out of the corner they painted themselves into by doing Roth conversions. Basically, trying to correct a situation we got ourselves into.
If, instead of putting an extra $10,000 into a 401(k), the employee bought the same investments in a brokerage account, the result would be different in retirement. The money grows, and if they take $10,000 out during retirement, they’ll pay a capital gains tax of 0%, 15%, or 20% only on the growth of the investment at the time they take the money out. For example, if the $10,000 put into the account doubles after a few years and you take out $20,000, you’ll pay either 0%, 15%, or 20% tax on the gain of the original $10,000, based on the total of other taxable income. Thus, less tax, or even zero tax, compared to the 401(k). Of course, you paid income tax on the money when you put it into the account because it wasn’t tax-deferred like the 401(k), but you don’t have the RMD to deal with after age 73, and when you die, you’re also not passing on a tax bill to your family.
A better solution to the question of maxing out the 401(k) is to use different types of accounts for retirement savings in the following order: (1) contribute only enough to the 401(k) to receive the company match, then (2) contribute to a Roth IRA up to the maximum annual amount*, and finally (3) put any additional amount into an after-tax brokerage account. This way, you’re spreading retirement savings across accounts with different tax treatment and rules, which can lower your retirement tax burden, reduce the risk of higher future tax rates, increase liquidity, and ultimately pass on a lower tax bill to your beneficiaries. The downside is paying more tax now because not all of your retirement savings will be pre-tax. But the benefits of this approach result in paying less tax in retirement and having more flexibility when taking money out and passing it on to heirs.
With the approach I described, you’re offsetting the negatives of the 401(k). However, to be clear, if your 401(k) is worth less than $1M at retirement, the RMD problem may not be as bad as you might think if you’re willing to give some to charity before you’re gone. A Qualified Charitable Distribution (QCD) allows you to distribute some or all of your RMD to charity, so it’s not included as income, which reduces the tax impact of the RMD. Have to take a $35,000 RMD? Give $25,000 to charity first, and now you only pay tax on the remaining $10,000. Therefore, you took advantage of tax-deferred contributions while employed, and you can reduce taxes when taking the money out if it’s given directly to charity. QCDs are currently limited to $111,000 per person per year.
Finally, the most important part of the “maxing out a 401(k)” question needs to be addressed: acknowledging that you are behind on saving for retirement. For many, the 50s arrive without much thought or planning for retirement, and when the light bulb turns on, the magnitude of the situation becomes clear. A thought like “maxing out their 401(k)” seems like the only available option. But there are always other ways to make the most of the time until you retire. Start saving more immediately, but before too long, take the time, or get some assistance, to assess where you are and where you need to get to. You can stumble into retirement, leading to some not-so-golden years, or you can do a little work and planning and have a much better outcome.
*Note that there is an earnings limit for Roth contributions. However, you can get around the limit by doing a “backdoor Roth.” This involves contributing to a Traditional IRA (which does not have an earnings limit) and immediately converting it to a Roth IRA. You’ll pay tax on the conversion, but it’s identical to the tax you saved when contributing to the Traditional IRA. It’s a perfectly legal and legitimate strategy. Your retirement account provider can assist with the process.
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