What to Do If You Can’t Max Out Your 401(k)

Today, the 401(k) is a standard way that Americans save for retirement. Because these plans provide tax benefits and a potential employer match, many investors aim to “max out” their contributions, or contribute up to the IRS annual limit.

For 2022, the contribution limit is $20,500 per year for workers under age 50, and $27,000 for those over 50. However, many employees cannot contribute up to the limit, depending on their personal financial situation. Others may find that maxing out a 401(k) is not ideal if the plan’s asset options don’t align with their goals.

In this article, we’ll look at how maxing-out your 401(k) works and what you can do if you cannot contribute up to the limit.

Should You Max Out Your 401(k)?

When you maxing out a 401(k), you maximize your tax benefits and create more financial security for your retirement. Your contributions to a traditional 401(k) plan are tax-deferred, so you won’t pay any tax on them until you withdraw them in retirement (when you’ll likely be in a lower tax bracket, anyway). With a Roth 401(k), you contribute after-tax money but then you can make tax-free withdrawals in retirement.

Some employers will also make matching contributions up to a certain percentage of your salary. So, for example, if you put $5,000 in your 401(k), your employer may also contribute $5,000. 

Potential Downsides of Maxing Out a 401(k)

But maxing out a 401(k) is not necessarily ideal for all investors. in fact, only about 3.6% of workers max out their 401(k), according to the IRS.

Some investors may not have the cash flow to deduct the maximum contribution from their paycheck. They may need to use their earnings for necessary expenses before saving the maximum for retirement.

In addition, depending on the company you work for, investing heavily in a 401(k) plan might not be the best choice for you. That’s because 401(k) plans provide different investment choices. Since your employer administers the plan, they decide what assets to offer. In some cases, your 401(k) investment options may be very limited.

Finally, some 401(k) plans may not be attractive because of high fees. 401(k) plans require management and administration, and 95% of 401(k) plan participants pay fees. Plans with lots of participants sometimes benefit from economies of scale, so they may have lower fees than those offered by smaller companies. According to 2021 report, the average fee for a 401(k) account ranges from about 0.88% to 1.19%, but your expense ratio could be much higher.

How Much Should I Contribute To My 401(k)?

If you decide to invest in your 401(k), you’ll also have to decide how much you want to contribute from your paycheck. For most, the tax advantages and employer match make a 401(k) the best place to invest for retirement.

A common rule of thumb is to aim to save 15% of your income for retirement. If 15% of your income is more than the 401(k) contribution limit, then you will need to invest your funds in another account to maintain that percentage of savings toward retirement.

If you can’t afford to max out a 401(k), aim to contribute what you can. Investing just a few hundred dollars a year will can help provide a source of funding for retirement. If your employer offers matching contributions, aim to contribute at least up to the limit of these so you are not leaving “free money” on the table.

Before contributing to your 401(k), consider paying down high interest debt, building up some emergency savings to cover unexpected events, and ensuring you are on track for your short-term financial goals (such as getting married or buying a house). After that, you’ll likely want to put as much as you can afford into your 401(k).

The Bottom Line

For most workers, a company-sponsored 401(k) is a good option to save for retirement. However, only about 3.6% of workers max out their 401(k).

There are also some circumstances in which it makes sense to invest your money elsewhere, such as if your employer offers a limited plan with high fees. In general, though, 401(k) plans offer substantial benefits, so maximizing contributions can boost your savings.