Unveiling the Unpleasant Truth Surrounding Maximum 401(k) Contributions
Did you realize that the typical retired worker collecting Social Security right now usually receives around $23,000 annually? Although this isn't a poor supplemental income, it's not overly generous either.
This is why it's vital to save for retirement independently and not solely depend on Social Security to cover your future expenses. When it comes to creating a retirement savings fund, many individuals turn to their employer's 401(k) plans due to the ease and benefits involved.
One advantage of 401(k)s is that they are funded through payroll deductions. Once you sign up, your retirement savings will be automatically funded without the need for you to remember to put money into your account each month.
Many employers that sponsor 401(k) plans contribute to a certain extent in response to employee contributions. This results in free money for retirement.
It's also worth noting that 401(k)s allow for significantly higher contribution limits than IRAs. This year, you can contribute up to $23,000 into a 401(k) if you're under 50 or up to $30,500 if you're 50 or older.
On the other hand, IRA contribution limits reach $7,000 and $8,000, respectively. Plus, the more money you put into a 401(k), the less income you'll have to pay taxes on (provided it's a traditional 401(k), not a Roth).
Maxing out a 401(k) could potentially result in a substantial retirement savings fund. However, despite the benefits offered by 401(k)s, there's a risk in maximizing your contributions.
An imperfect savings solution
There are indeed many positive aspects of 401(k) plans. However, there are potential drawbacks you might encounter with a 401(k), notably.
You could have limited investment options. Unlike IRAs, which allow for diversifying your investments in individual stocks, 401(k)s usually restrict you to various funds. This can be problematic because:
- You forfeit the chance to personalize your portfolio when you invest in a fund.
- Being restricted to funds in your 401(k) could mean paying expensive fees, known as expense ratios. And if these fees are high enough, they could significantly reduce your returns.
Fortunately, there are methods to minimize investment fees in a 401(k) plan. If you invest in index funds, for example, they usually have lower expense ratios compared to actively managed mutual funds.
Additionally, many 401(k)s offer target date funds, which are convenient "set it and forget it" types of retirement investments. But, using a target date fund could result in paying costly fees, although it is an acceptable option if you prefer a less hands-on approach to building your retirement savings.
If you have a knack for choosing investments or are interested in learning, a 401(k) may not be the ideal location for your long-term savings. You could get frustrated by the lack of control and annoyed by the substantial fees that reduce your returns.
A better approach
If your employer offers a 401(k) match, it's wise to contribute enough to your workplace plan to receive the full match. However, once you've secured the match, you might want to consider other retirement savings options. This could involve relying on an IRA, combined with a taxable brokerage account.
Although the taxable brokerage account won't provide any tax advantages, it won't restrict you in any way. You can withdraw funds from a taxable brokerage account at any age without penalties and contribute as much as you want annually.
While participating in an employer's 401(k) plan has its merits, contemplate carefully before maxing out your contributions.
It's essential to supplement your retirement income beyond what Social Security provides, given that the typical annual Social Security payment is around $23,000. By maximizing your contributions to a 401(k), you could potentially build a substantial retirement savings fund, especially considering the higher contribution limits compared to IRAs. However, you should also consider the investment options available in a 401(k), as they may be limited and potentially more expensive than those in an IRA.
%20Contributions){kind=link}