Here’s What Happens When You Max Out Your 401(k)

Image source: The Motley Fool/Upsplash

If you want to optimize your retirement, maxing out your 401(k) may be a goal you set every year. And it’s an admirable one: It ensures that you’re putting away a solid chunk of your income into a retirement savings account where it can grow over time. But is it always a good idea?

Here’s what you should know.

Bonus offer: unlock best-in-class perks with this brokerage account

Read more: best online stock brokers for beginners

It minimizes your taxable income now

One of the key benefits to maxing out your 401(k) is that it means you’ll be reducing your taxable income by putting it into your retirement brokerage account, thus reducing your tax liability. Of course, as with any retirement account, that’s because there is a trade-off: You’ll have to pay taxes on that amount when you withdraw it in retirement. So, assuming you earn more in retirement, that would be a higher percentage of your money going to taxes — and vice versa.

There can be consequences for taking out that money early

Now let’s look at the flipside of the maxing-out-your-401(k) argument: What happens if you run into trouble and need that money you already stashed away in your 401(k)? These accounts were designed to hold your money for decades and support you after your working life has ended, so there are consequences for taking early withdrawals.

For a 401(k), that means withdrawals taken before age 59 1/2 would incur a 10% tax, on top of regular income taxes. A $10,000 early withdrawal, for example, could cost you $1,000 before income taxes.

Four tips for successfully navigating the retirement savings question

Saving for retirement is important, but so is ensuring that you’re keeping up with your various expenses as a working person. To find that balance, make the following moves.

1. Figure out your ideal monthly budget

If you don’t have a working budget, now is the perfect time to make one. And remember that these are meant to be flexible, changing as you need them. So it’s best to regularly revisit your various spending habits to make sure they’re still serving you. But as a start, creating a budget will help you understand how much you can safely stash in a retirement account each month.

2. Make sure you’re accounting for emergency savings

It may be tempting to skip on the emergency fund contributions, especially if you’re new to the working world or you’re on a tight budget. But it’s the best defense against having to take money out of your retirement accounts if you get an expensive unplanned bill. Aim to save three to six months’ worth of necessary expenses, like rent, utilities, and food.

3. Set aside some of your retirement savings in a high-yield savings account

This may sound counterintuitive if you’re looking for the maximum contribution, but for those who may be worried about the consequences of pulling money out of a retirement account in a pinch, a savings account can be a useful option. This way, that money could sit in an accessible account during the year, and then at the end, you could decide to add it to an IRA and still get the tax benefits.

4. Talk to a financial advisor

If you aren’t sure where to start for handling the question of how much to save for retirement, a financial professional can help guide you. They might also be a good resource for creating a budget that also helps you pad your emergency fund.

Maxing out your 401(k) can absolutely be a solid way to invest your money. But for those who aren’t on the most solid financial ground yet, or who simply have many other goals on their plate, there may be other methods that can still lead to a secure retirement.

Alert: our top-rated cash back card now has 0% intro APR until 2025

This credit card is not just good – it’s so exceptional that our experts use it personally. It features a lengthy 0% intro APR period, a cash back rate of up to 5%, and all somehow for no annual fee!

Click here to read our full review for free and apply in just 2 minutes.

We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.

Here’s What Happens When You Max Out Your 401(k) was originally published by The Motley Fool