TradeEdge-Here's what can happen when you max out your 401(k)

Maxing out your 401(k) is TradeEdgeno easy task. In 2024, it means setting aside $23,000 in savings, or $30,500 if you're 50 or older. That kind of annual contribution could turn into a significant nest egg by retirement -- enough to cover many years of living expenses.

It seems like a smart, albeit lofty, retirement savings goal. But there are actually some drawbacks to maxing out your 401(k). Here are the key factors to consider before attempting to do so.

It locks up your cash

You generally cannot access money in your 401(k) before you turn 59 1/2. Withdrawals under this age are subject to a 10% early withdrawal penalty on top of applicable income taxes. There are only a few exceptions for things like large medical expenses or tuition.

Due to these restrictions, it's not a good idea to put money into your 401(k) that you plan to tap into for emergencies or expenses before turning 59 1/2. Keep these funds in something like a high-yield savings account where you're free to withdraw them as needed.

It might not be the right account for you due to fees or tax treatment

Some 401(k) plans charge high administrative fees that eat into your gains, or they may only offer a limited number of mutual funds that require you to pay a hefty expense ratio to the fund manager.

If you have access to a 401(k) match, then you might overlook those shortcomings to at least take advantage of your employer's matching contributions. But if not, you might want to explore other options. You could stash money in an IRA first, which gives you access to more investment options than the usual 401(k). Once you've maxed it out, you can return to your 401(k) and set aside any remaining funds there.

In terms of tax treatment, you fund a traditional 401(k) with pre-tax dollars, meaning your contributions reduce your taxable income this year, and you pay taxes on your withdrawals later. But some people prefer Roth savings, which require you to pay taxes on your contributions in the year you make them while giving you tax-free withdrawals in retirement.

An increasing number of employers now offer Roth 401(k)s for those who want Roth savings and the benefits of a 401(k). If this isn't an option for you, you can use a Roth IRA first and then switch back to your 401(k) after you've maxed it out.

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But while Roth savings are definitely nice to have in retirement, if you have the spare cash to max out your 401(k) today, you're probably in a high tax bracket right now. Using a traditional 401(k) and deferring taxes until retirement could help you save money.

None of this is intended to discourage you from contributing to your 401(k), though. It can be a great way to increase your retirement readiness, but you don't have to max out your account in order to reap these rewards. Start with the accounts that offer the greatest advantages for your personal situation, even if it means a smaller contribution to your 401(k).

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