3 reasons I’m not maxing out my 401(k) this year, even though I can afford to

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My obsession with my 401(k) runs deep. I’ve watched my balance grow from nothing to more than $90,000 in under five years through a combination of my own savings, employer matching contributions, and investment returns.

The employer-sponsored 401(k) has one of the highest employee contribution limits of all tax-advantaged retirement accounts. Workers can save up to $19,500 of their own earnings annually for 2020 and 2021, plus an extra $6,500 if they’re over age 50.

So far this year I’ve added over $10,500 to my 401(k). While I can afford to keep going and “max out” my account, or reach the annual limit, I’m not going to. Here’s why.

1. I’ll get my match before maxing out

Not all types of 401(k)s require an employer to make yearly contributions to their employees’ plans, but many do through matching. A 401(k) employer match is akin to a guaranteed return. For every contribution I make to my plan, my employer will match it up to an annual ceiling. I’d be silly to leave it on the table.

Thankfully I’ll get the full match this year before I hit the annual IRS contribution limit. Since my goal is to save 20% of my income toward retirement, I’m using the difference to build up another retirement account that’s taxed differently: my Roth IRA.

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2. I want to diversify my retirement income

Diversification — investing across and within different asset classes to minimize risk — is key to being a successful investor. The same concept applies to retirement planning. It’s best not to put all your eggs in one basket.

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Utilizing a traditional 401(k) means I can put the whole dollar into investments, not just the portion that’s left after taxes. But after decades of growth, I will eventually have to pay taxes on the contributions and investment earnings when I withdraw them in retirement (generally after age 59 and a half, with a few exceptions).

Practically, that means I’ll end up with less in my pocket than I see in my account — and who knows what the tax code will look like in 30 years. Even if I leave my job and roll over my 401(k) into an IRA, I’ll have to pay taxes on the money at some point in the future.

So, instead of frontloading my retirement savings into a tax-deferred account, I’m also using a Roth IRA, where I can stash money I already paid taxes on. The annual contribution limit is lower — up to $6,000 a year of earned income — but when I turn 59 and a half, I’ll have a pot of totally tax-free money to draw on.

Real estate is another retirement income source I plan to build in the future, since it’s completely separate from the stock market.

3. I may want to retire early

I don’t have an exact retirement plan right now, but I prize flexibility. I want to have the freedom to retire early, but I’ll need a source of income. A 401(k), and even an IRA funded with a 401(k) rollover, has stricter withdrawal rules than a Roth IRA. I can incur a bunch of taxes and penalties if I dip into the account too early.

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Contributions to a Roth IRA, however, can be taken out at any time, tax- and penalty-free, since I already paid taxes on the money before funding the account.

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Withdrawing earnings before I turn 59 and a half can trigger a 10% penalty (which is basically a tax) but there are even exceptions to that rule, including if the money is being used for college tuition or a first-time home purchase.

At the end of the day, I want to have options. Saving a lot of money is good, but being strategic is even better.

Related Content Module: More Retirement Coverage

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By: Tanza Loudenback
Title: 3 reasons I’m not maxing out my 401(k) this year, even though I can afford to
Sourced From: www.businessinsider.com/personal-finance/not-maxing-out-401k-retirement-strategy-2021-8
Published Date: Sat, 14 Aug 2021 09:10:00 -0400

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