Simply because you’re able to do something doesn’t mean that you necessarily should. Like jumping off a bridge, for example. Or getting a hand or face tattoo. Or possibly even maxing out your 401k.
One of these does not match the others. Ha! While maxing out your 401k seems like a good idea (and it is), especially because the majority of Americans are not actively saving enough for retirement, there may be a few other considerations to look into first.
Many personal finance blogs will tell you to save, save, and then save some more. This is great advice. However, depending on your age and your situation, there may be a better use of your money than throwing $18,000 into an employee-sponsored retirement fund.
Not living in the here and now
While it’s great that you’re thinking of the future, are you ignoring slightly more pressing issues here and now? You’ll be so grateful, 20, 30, or even 40 years from now once you’ve got a nice nest egg waiting for you, but that doesn’t mean you should be completely ignoring things in your life at the present.
Take a step back and look at the larger picture. Are there things you can do currently that will help springboard your future?
- Do you have high-interest credit card debt? Or even worse, multiple cards with high-interest? Pay those cards off as soon as possible. When you’re not paying interest, you’ll have more to contribute to retirement or other debts.
- Do you have an acceptable emergency fund? By “acceptable”, we recommend three to six month’s worth of expenses.
- Have you and your spouse taken care of setting up a will, to allocate assets in the event of death of a loved one? Do you also have adequate life insurance to care for those in case you’re not able to?
- Do you and your family have suitable healthcare coverage? Not having enough coverage can cause a huge financial burden should an unexpected health problem arise and you’re left footing the bill entirely by yourself.
While these are only just a few suggestions, they’re absolutely imperative to your financial well-being. Before you look towards maxing out your 401k, make sure that these items are in place and taken care of.
Now versus Later
Retirement planning is a tricky see-saw balancing act that seems all too fickle. If you keep too much for yourself in the here and now, you may find yourself dipping in your retirement funds too early (and accruing a 10% fee if it’s before the age of 59) to supplement your current lifestyle later. If you save too much money, you may deprive yourself of the basic necessities of life, along with some of the more enjoyable ones as well.
Many people are not currently on track to reach their retirement goals. I currently work with a man who recently turned 60 years old. He has 5-7 years left until he retires, and he reported to me that he only has about $400,000 saved for retirement. Although he’s single, and has no kids left at home, he still has yet to pay off his home and his medical bills are steadily increasing. He’s expressed concern to me that he may not have enough, and so he’s now buckling down in order to save as much as possible until he retires. Even if he saves 100% of his paycheck (which isn’t possible) for the next 5 years, he’ll be about $500,000 short of what he will need to sustain him through the next 25 years of his life. While he may have had an enjoyable life up until this point, he’s now regretting not starting his retirement plan sooner.
So what can you do? How can you know whether or not you’re saving too much or too little? Well, I’d venture to say that most people are saving too little. If you’re not contributing at least 15% to retirement, you may be hurting come age 67. Start small. Start by meeting the basic employer matching on your 401k until you have other funds and securities taken care of first. From there, you can begin working up to the $18,000 mark.
Other investment opportunities
Let’s say everything is great, as far as your finances go. You’re able to contribute a full $18,000 per year, but are still trying to decide whether or not that’s the correct plan of action. Have you considered other opportunities first?
One of the poor things about a 401k is that it doesn’t actively pay you. Yes, you’ve contributed money into it that you’ll be able to tap into later, but it doesn’t physically make you money. You simply get what you put into it, with interest. Consider, perhaps, real estate. By dumping your $18,000 into a rental property, not only have you not lost any money (which is possible with a 401k based on market trends), but you’re actively making money on rent, and your property is appreciating at an estimated 3.5% each year. If you’re able to set aside $18,000 per year, that’s a down payment on a new property every year or two.
If you’re against the idea of a rental property, perhaps you might think about investing in a Roth IRA. “Roth” simply means “after tax”. This is money that you’ll contribute on your net paycheck, as opposed to your gross with a traditional 401k. The benefit with this is that you may be able to avoid some of the higher fees you may find with a traditional 401k. Keep in mind, however, that contribution rates on a Roth IRA are much lower than a 401k. You’ll be able to contribute a maximum of $5,500 as opposed to $18,000. Take the excess and redirect it back into your 401k.
What’re the other differences between a 401k and a Roth IRA, you may ask? The difference comes down to how and when you’ll be taxed. With a 401k, you’re not taxed on the money that you place into it. You will be, however, when you withdraw those funds. So why does it matter? Tax brackets. Let’s say you begin your working career, making $50,000/year. That’s great! You fall in the 25% tax bracket. But this doesn’t apply to you much, in regards to your retirement funds, as they’re tax free. However, when you retire you’ve climbed the corporate ladder and are now making $200,000/year 40 years later. Rather than being in the 25% bracket, you’re now in the 33% tax bracket, which is significantly higher. When you pull your funds out during retirement, you’ll be taxed at the 33% rate instead of the 25%. In this situation, you would’ve been better off placing money in a Roth IRA and paying taxes on the 25% instead of the 33%.
Ultimately, when it comes down to it, if you’re maxing out your 401k, there are worse situations you could be in. However, you want to make sure that all other aspects of your financial lifestyle are met first. From there, you can explore other investment opportunities that could make you even more money.