The Unfortunate Truth About Maxing Out Your 401(k)

Saving in your 401(k) makes a lot of sense, but don’t forget the downsides.

Any time you decide to divert money to a retirement account, you’re undoubtedly making a commitment toward your financial future — and that can’t be ignored. As with any long-run investment, the more money you add early on, the more time your account has to take advantage of compound interest. At the same time, maxing out your 401(k) does come with a few real-world downsides. Here, we’ll reveal the unfortunate truth about maxing out your 401(k).

Your 401(k) money isn’t for current use

Unsurprisingly, money saved in retirement accounts is meant for one thing: Retirement. There are ways to withdraw money from your 401(k) or other qualified plan before you retire, but if you haven’t yet turned 59 and a half, you’ll be subject to an early withdrawal penalty of 10% on any amounts taken out. That penalty is in addition to any income tax due, which will be levied on the entire amount you withdraw from your pre-tax 401(k). This is all to say that the IRS strongly discourages taking 401(k) money out before you’ve reached a more advanced age. This can be an issue if you need a large amount of money to cover current cash needs, like a down payment on a house or the first few years of child care expenses. While you will be helping your future self by maxing out your 401(k), you’ll have to be careful not to forget about your current self as well.

Your 401(k) may be subpar

This of course varies from provider to provider. But the reality is that nearly all 401(k) plans come with a fixed menu of mutual funds from which to choose. You won’t have the ability to access other investment options, like individual stocks, bonds, and exchange-traded funds, and especially more esoteric investment options like cryptocurrency. This means that a maxed out 401(k) might limit your ability to invest in what you want, and that’s an issue for some people. Additionally, some 401(k)s come laden with high administrative fees and expensive mutual fund options (via high expense ratios), so it’s not always a smart idea to divert every last dollar to an exceedingly expensive account. This is most definitely not true of all 401(k) plans — some are quite attractive. But some legacy plans are still behind the curve when it comes to the amount they charge participants for plain vanilla investments.

You may have a more complex financial picture

Contributing the maximum to your 401(k) makes a lot of sense when viewed in a vacuum. But you might have certain aspects within your overall financial circumstance that require more attention. Specifically, if you have high-interest credit card debt, you might find yourself with a falling net worth even if you contribute the maximum to your 401(k). In these scenarios, it’s often wise to contribute to your 401(k) up to the employer match (if your company offers one) and direct other money toward your debt until it’s extinguished. This is just one example, though there are various situations in which sending the max off to your 401(k) is a weaker choice than tackling other areas of your finances. Depending on your tax situation — especially if you’re in a lower tax bracket —  you might want to max out your Roth IRA before contributing money beyond your company match to your 401(k).

The unfortunate truth, explained

The bottom line is that contributing to your 401(k), when viewed by itself, is a smart idea for most people. But like any financial decision, there are often complexities that are worth examining. In the case of maxing out your 401(k), you might be sacrificing other opportunities that matter to you today, and you also might be forgoing other less expensive and more accessible investments. The decision is ultimately yours, but make sure to consider your entire financial picture before devoting the max to your employer-sponsored retirement plan.