Why you may want to Rethink your 401(k) Contributions
Most people think maxing out their 401(k) is the best way to save for the future, but that’s not necessarily true. The maximum federal contribution in 2024 is $23,000. For the longest time, my husband and I contributed these yearly maximums, hoping to get ‘ahead’. In hindsight, we believe, this was pretty foolish! Getting ‘ahead’ was only us throwing money at a pot of savings we couldn’t touch until we were retirement age - 59.5!
While we think it is wise to contribute enough to get the full employer match, we started contributing our additional savings into an individual brokerage account instead. While earnings on brokerage accounts are taxed now, at least you have access to them without penalty anytime you want and you can borrow money secured from them! Our rule of thumb was to at least match what we put into our 401(k) into our individual brokerage.
The purpose of a traditional 401(k) is to let money grow tax deferred. It is taken out before taxes on your paycheck and instead you pay the tax when you take distributions in retirement. While it lowered our current adjusted gross income, my husband and I have no illusion that our tax brackets will be less when we retire especially given the current national debt and considering how we want to live at that time (traveling, splurging on kids and grandkids, still likely paying for a home, etc.). If you want to access this money in a 401(k) or IRA before retirement age, you are subject to a 10% early withdrawal penalty in addition to paying taxes on the distributions taken.
Likewise, the purpose of a Roth 401(k) is to pay tax now and let it grow and be distributed tax free. A Roth allows you to have access to this money after your account has been open for 5 years without paying an early withdrawal penalty of 10%. While this is a great option, a limitation to Roth 401(k)s is that you cannot contribute to it if your combined income is greater than $230,000 (o $146,000 for single filers, as of 2024). That makes it a non-option for a lot of people. If we were beneath this threshold, then we would have invested in a Roth over a traditional IRA, but still only matching what our employer would contribute.
Regardless if your money is in a traditional or Roth 401(k), the limitations of a company 401(k) are that the investment options are not always great and you can’t borrow money secured by these investments which is a big reason we don’t personally like them.
For more, see our 10 practical tips to implement while working your 9-to-5 to realize the dream of early retirement and our current strategy for financial freedom!
What do you think? Still want to contribute the federal max to your 401(k)?
FINANCIAL DISCLAIMER
Do your own research! We are not providing nor are we intending to provide any sort of financial, tax or legal advice. This article simply includes practical tips that we’ve compiled based on our independent analysis, implementation, and realization of the results - which changed our lives. Everything is of course, subject to market fluctuation. Please always be informed and consult your professionals prior to making changes.
