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If you have a full-time job, you should have a 401k. This is one of the most basic employee benefits that an employer can offer, providing you with a pension fund. It’s an employer-contributed fund, meaning your employer will add money to it, along with anything you put into the fund. If you’re looking to maximize the savings from your 401k, you might have come across the idea of maxing it out. What does this mean, and does it make sense?
What happens when you max out your 401k?
Maxing out basically means that you reach the maximum contributions you’re allowed each year. Currently, this is set at $19,500, meaning you can contribute up to that amount in 2021. It might change next year, and then you can contribute up to the limit again. If you go over this, you could be hit with some tax charges, so make sure you don’t!
Why should you max out your 401k?
If possible, it’s advised that you try to reach the maximum contributions every year. Why? Because it means that you’ll see the maximum benefits from your 401k. Let’s say your employer agrees to contribute 50% to your 401k, meaning they invest half of whatever you contribute. By maxing out, you ensure that they contribute as much as possible. In turn, this leads to more savings for your retirement.
What should you do if you max out your 401k but still have money to spare?
High earners will regularly be in this position! If you can afford to save the maximum limit each year, and still have money left over to save, what should you do? Don’t invest it into your 401k as you’ll go over the limit and be penalized. Instead, you should consider other retirement plans to make use of your additional savings. You can learn more here about one of the most popular options for high earners, the Mega Backdoor Roth. Also, think about investing your extra savings in stocks, property, or anything else that should appreciate in value over the years.
Why shouldn’t you max out your 401k?
Reaching your limit is advised, but there are instances where you shouldn’t do it. Primarily, this is when you simply don’t earn enough to meet the maximum contributions every year. Imagine you earn $50,000 per year, you’d have to save nearly half of your income to reach the limit. This might not leave you with enough money to live a comfortable life and pay your bills. So, maxing out isn’t a good idea when it could potentially damage your finances. The best solution is to speak with a financial advisor so they can assess if you earn enough to max out your contributions or not. If it’s too risky and leaves you in a dangerous financial situation, don’t do it!
401ks are very handy for employees to save for retirement. If you have one, make a conscious effort to contribute to it as often as possible. The more you save, the more you get in your retirement.