Are Maximum 401k Contributions Best for My Asset Management Strategy?
Topics: Income level, life changes, limited investment choices, FIRE, withdrawals at 59 ½, RMDs, Roth conversion ladder
In my latest blog post I asked the question: How Do I Get Out of Credit Card Debt and Start a Budget?
I’m going in an opposite direction with the question I’m asking today in the title of this post. The simplest answer for me is…”No” – if I have to pick “Yes” or “No” that is. There are reasons for both answers in my mind, but it’s a question specific to each individual. It wouldn’t surprise me if most advisors or investors disagree with me. Better questions before answering that one: What is your current financial status? What are your goals and plans?
The maximum amount an individual can save in a 401k account in 2023 is $22,500. (Substitute “403b” for “401k” for the educators and medical types – some of my favorite people!) If you have a firm set of goals and developed a plan that allows you to live your lifestyle and put $22,500 into your 401k, then you should probably do it. If you have NOT established goals or plans for your financial future, you should talk to a financial advisor. I know someone! firstname.lastname@example.org.
In our personal story, my wife and I have always made it a goal since we got married 17 years ago to save for retirement. Even before that actually. But since then we’ve had to pay for more college degrees, a few houses and three kids (while thinking about their future too – gulp!), so while we wanted to save more, doing that and enjoying things in life we had become accustomed to became a challenge. So our goal has always been to try to get back to max savings, but the ups and downs of life don’t always allow for that.
I read Robert Kiyosaki’s book Rich Dad Poor Dad probably 15 years ago (and again recently) and have had an ongoing interest in real estate since then. Without knowing at all what we were doing, we became landlords renting out properties we bought and didn’t sell when we moved (some good experiences and some not so good). But about 10 years ago, I became a student of real estate and it became very important to me to invest and develop a better strategy for myself as part of my Asset Management strategy. This time I wanted to do it the right way with a better understanding of my own rules and return expectations. So for us, savings into retirement accounts was sacrificed but the end goal actually had more purpose – not just retirement at 65 but financial freedom. And we constructed a lifestyle today that (mostly) fits with what we are trying to achieve in the future. We just have to stick with it for the next few decades.
What if I have credit card debt?
If you read my last post and credit card debt is a challenge, you might not even be thinking about retirement, or putting money into a retirement account. And while it’s important to develop your plan to eliminate credit card debt, you must still consider your contribution into your retirement account. Your best return on investment continues to be contributing to get your company match – I would consider that a 100% return. Not to mention the long-term impact of the compounding effect in your savings and the positive habit of “paying yourself first” through automatic contributions into savings. So I encourage you to save money into your 401k account at least to the extent your employer provides a match. Then focus on eliminating your credit card debt.
So…Should I Max Out My 401k?
While it sounds like a good idea, it isn’t for everyone, and even if it’s financially possible, there’s more to consider than the ability to save. Below I discuss 6 reasons why you might not contribute all you can to your 401k plus some brief notes on Roth investments, so read on!
Why not make max 401k contributions?
If you aren’t investing the maximum possible into your 401k, you are in the strong majority, so you certainly should not feel badly about it. A study conducted recently suggested that just 13% of plan participants were able to max out contributions to their 401k. On the other hand, if you’re like most of us that are still reaching and sacrificing to save, perhaps a better rule or at least a starting point is contributing 10% of income toward retirement. I read to be in the top 50% of wage earners, you would need to make about $30,000 per year. So saving $19,000 (nearly two-thirds!) of your salary toward retirement for the average wage earner seems pretty outrageous (and unlikely allowed by your employer), but $3,000 (or $250/month) would be a tremendous start for the average employee. To contribute 10% of your paycheck and hit the $19,000 contribution limit implies a $190,000 salary, which would put you near the top 2-3% of wage earners! Congrats! So for those making less than that and hitting the limit, your savings are off to a great start, but again, depending on your income, maxing out your 401k may not be your best option.
Even high-income earners often struggle with saving. Job changes, buying a house, having kids, medical bills, or education costs (yourself or kids) can create the need for significant changes in allocating your dollars, often at the sacrifice of retirement savings. In the event of an emergency, hopefully you can utilize your emergency account funds and/or reduce your savings rate temporarily to get back on track, but often these changes have a lasting effect and maxing out your 401k just doesn’t make sense at that moment. The goal remains though to get that savings rate back up with the future in mind and your financial plan intact.
Limited investment choices
My purpose in becoming an advisor is to help educate investors and provide alternative options to traditional asset portfolios – to include assets where the market is less efficient. My initial blog discussed the multiple options of 401ks, and while that’s adequate for the typical portfolio, a new way of thinking (see FIRE below) suggests otherwise. The standard 401k plan will typically not allow more creative options, such as investing passively in business and real estate, which can often provide great tax-advantaged passive income, so real estate investors are probably better off paying taxes and using the after-tax income to buy investment properties. Investing in businesses that are not related to real estate is generally prohibited within 401ks except under specific structures. If you don’t like the choices in your 401k plan, you may be better off making investments elsewhere.
Playing with FIRE
I certainly can’t take credit for that topic heading, and I've written a blog post on “FIRE” or Financial Independence/Retire Early. There is a strong movement for many to achieve levels of passive income that support their expenses. Genius! To achieve this lifestyle, however, you may need to direct funds normally sent to 401ks pre-tax into an investment vehicle after paying taxes to build your passive income portfolio. Real estate is frequently used at least as a component of the portfolio for those pursuing FIRE, so if that is your plan, then maxing out the 401k may not fit with the goal of achieving Financial Independence.
Withdrawals at 60 (59 ½ actually)
To tap 401k and IRA funds you must be 59 ½ years old, which I assume is the reason FIRE is just gaining traction and most “retirees” are at least 60. In the event you need emergency cash, any withdrawal of funds prior to 59 ½ will create a 10% penalty for early withdrawal and you pay taxes on the distribution according to your regular tax rate, which could be bumped up to the next level if you are already near the top of your current bracket and the distribution is large enough. So, there might be better alternatives to maxing out your 401k and locking up your money until your almost 60. To me that’s a pretty arbitrary number – why wait until your 60?
Furthermore, as you may have guessed, when it comes to the Required Minimum Distribution (or RMD) you are required to take a distribution – it currently starts the year you turn 72. Using money that you have saved a lifetime for doesn’t sound like much of a problem, but for those savers who might have a pension or social security or other sources of income that meet their needs, this creates an unnecessary tax burden. So, if you know you might have other sources of income, then there could be a more tax-efficient strategy than dumping all the money you possibly can into your 401k. Additionally, a 401k passed to heirs remains taxable to them even if converted to an IRA at some point, so a better option to avoid the RMD is a Roth IRA. These assets are funded with after-tax dollars but grow tax-free and can be passed on to heirs that will also benefit from tax-free growth and withdrawals.
A Roth IRA has a $6,500 contribution limit in 2023 but income limits apply. A Roth 401k is not offered by as many employers as the standard 401k but income limits don’t apply and this can eventually be rolled into a Roth IRA. One very noteworthy topic is the Roth IRA conversion ladder, which I did not fully appreciate as a tool for the FIRE movement. View the sources at the end of this post for more info, but the idea is to gradually make partial rollovers of your traditional 401k to a Roth IRA after early retirement to lower tax implications of the transfer (based on your lower “retirement” income). You’ll need income from other sources for 5 years though since accessing funds prior to that time will still trigger the 10% penalty.
In summary, I’m obviously a big fan of saving for retirement, but that can mean different things to different people and each individual has different circumstances with multiple considerations. The best option is to develop a plan for what retirement looks like, it’s timing and feasibility and then see if your current savings rate will be adequate. Investing before taxes is great, but not necessarily optimal in each situation, and ideally you can reduce your debt burden and increase your savings rate to the point where investment both before taxes (in your 401k) and after taxes is a possibility. You then have greater options for cash flow, tax advantages or retiring ahead of schedule.
If you or someone you know has any financial-related questions, I would love to have a conversation, so please feel free to reach out: email@example.com.
And please don’t forget to view our prior blogs:
And stay tuned for upcoming blog posts where we discuss paying off your mortgage early (or not), and what early retirement might look like.
Best wishes on your financial path!
This post was created by Matt Beeby, the Founder of MHB Advisory Services. Matt has been working in Financial Services and investing in real estate since 2005, though his investment experience spans nearly two decades. He is a Christ follower, active in both his church and his neighborhood association. Matt enjoys sports and family time. Read more about Matt on his website bio.
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