3 Reasons Not to Max Out Your 401(k)

If you have a 401(k) at work and your employer offers a company match, you should make investing enough to earn that match an absolute top priority. Chances are good, though, that you’ll earn that full match well before you hit your 401(k) contribution limit.

If you have money to save for retirement after earning your match, it may be tempting to keep funneling it into your 401(k) to save for your retirement. After all, it’s really easy to do that — you just sign up to have additional contributions taken from your paycheck until your account is maxed out or as close to it as you can afford.

While that may seem like a good idea at first glance, though, there are actually three important reasons why you may not want to contribute the maximum allowable amount to your 401(k) plan. 

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1. You may get hit with high investment fees in your 401(k)

One reason you may want to avoid maxing out your 401(k) is that you could end up paying a lot of unnecessary fees. Some 401(k) plans charge administrative fees. Even in those that don’t, the investment options available to you within the retirement plan may be more expensive than the investments that you can access outside of it.

That’s especially true if your 401(k) tends to have a ton of options that are target date funds. These target date funds are convenient and simplify retirement planning since they adjust asset allocation for you as you get nearer to retirement, but they tend to be an expensive way to invest.

When you are investing for retirement over many decades, even small fees can add up and dramatically reduce your returns. You need plenty of retirement money to supplement your Social Security benefits, so you don’t want to lose more than is necessary to investment expenses.

Research the administrative and investment costs you are paying when you invest in your workplace 401(k), and if it turns out those costs are higher than the alternatives, invest just enough to earn your full employer match before reallocating the rest of your retirement funds to other tax-advantaged accounts.

2. You’ll have fewer investment choices

As mentioned above, the first problem with maxing out a 401(k) is that the investments within the account may not perform as well as those that you could find elsewhere. This brings up the second reason not to max out a 401(k) after earning an employer match.

When you invest in a 401(k), you’re limited to buying only the assets available within it. In most cases, this means choosing from a dozen or fewer different investments. You cannot buy individual stocks in most 401(k) plans, and even the exchange-traded funds (ETFs) available to you will be limited.

If you want a wider array of different investments to choose from so you can maximize your potential returns, look into putting money into other retirement accounts outside of your 401(k). For example, you can open an IRA with any brokerage firm, and that will open up the door to invest in almost anything you want.

3. The tax breaks may not be the best ones available to you

Finally, while a 401(k) provides an upfront tax deduction in the year you contribute to the account, this may not be the most valuable tax savings for you.

If you qualify for a health savings account (HSA), you can get a triple tax break, including

• Tax-free contributions
• Tax-free growth
• Withdrawals made tax-free when covering qualifying medical expenses — or taxed at your ordinary income tax rate like a 401(k) if you’re older and taking the money out for non-healthcare expenses.

If you can contribute to an HSA, that should be your next priority after earning your 401(k) match in most cases. Don’t try to max out your 401(k) while leaving this valuable account unused.

Even if you are not eligible for an HSA, alternatives like a Roth IRA allow you to defer tax breaks until retirement, as withdrawals are made tax-free. You don’t get to save on taxes upfront in the year of your contribution, but you will end up better off by deferring the tax savings if you are in a higher tax bracket in retirement than during your working life. You can also potentially avoid tax on Social Security benefits, since distributions from a Roth don’t count in determining whether you hit the income threshold where benefits become taxable.

Ultimately, there are plenty of other great retirement accounts out there that come with tax breaks and more investment choices. Before you max out a 401(k), look into these other options. Earn your match, then make a fully informed choice about what to do next.