Maxing Out Your 401(k) Contribution Isn’t Always the Best Move

Maxing out your 401(k) contributions is often seen as a smart move. It can help you save more and reach your retirement target sooner, get a higher employer match, offer better tax benefits, etc. But it is not always the best choice for everyone, and in some cases, it may actually be better not to max out your 401(k). Depending on your financial situation, there might be better ways to allocate your money and divert your funds elsewhere.

This article will explore when maxing out your 401(k) might not make sense and help you figure out how much you should put into a 401(k). You can also consult with a financial advisor and find out if the max yearly 401(k) contribution makes sense in your case.

Below are some of the reasons why maxing out your 401(k) contribution is not always a smart move:

1. 401(k)s may offer limited investment options

One of the drawbacks of 401(k) plans is their limited investment options. Most 401(k)s restrict you to a predefined selection of funds, which might include target-date funds, index funds, etc. While these options can cover your basic investment needs, they may lack variety. If your plan is filled with high-fee funds or poorly performing options, these can hurt your long-term financial growth. High fees combined with limited choices can significantly reduce your returns. Even if you are diligently maxing out your 401(k) contributions, subpar investment options could lead to subpar results.

This is why it is essential to carefully review the investment options in your 401(k). Look at the expense ratios and past performance of the available funds and consider whether they align with your financial goals. If you find that your 401(k) lacks good options in a major asset class, such as sector-specific stocks, small-cap funds, etc., you may want to diversify outside of your 401(k) to fill those gaps.

For instance, if your 401(k) does not offer strong funds, you can use an IRA or a taxable brokerage account to invest in the options you like. This will allow you to maintain a well-balanced portfolio without being entirely dependent on your 401(k) plan. Diversifying beyond your 401(k) ensures that your investments are aligned with your financial objectives and helps lower the risk that comes with the concentrated 401(k) options.  Ultimately, the goal is to maximize your retirement savings while achieving a diversified portfolio that matches your risk tolerance and time horizon.

2. 401(k)s come with high fees

Understanding the costs associated with your 401(k) is essential to ensure you are not losing a large portion of your savings to fees over time. While 401(k) plans are a popular way to save for retirement, they can come with higher fees compared to other options like Individual Retirement Accounts (IRAs) or Health Savings Accounts (HSAs). The fees on 401(k) plans can range anywhere from 0.5% to 2% or more. Generally, the more services offered by the plan, the higher the fees. Factors such as the size of your employer’s plan and the number of participants can also significantly impact these costs. Companies with larger 401(k) plans, those with over $100 million in assets, tend to have lower fees, typically below 1%. Smaller plans, with less than $100 million in assets, often have average fees between 1.5% and 2%. There are three main types of fees associated with 401(k) plans – investment fees, plan administration fees, and individual service fees.

It is essential to understand your plan’s costs and make informed decisions to keep fees in check. Start by reading your 401(k) statements. These documents usually outline the fees associated with your plan and provide a clear picture of how much you are paying. It is important to pay special attention to the expense ratios of the funds you are invested in. Lower ratios are typically better for long-term growth. For instance, Exchange-Traded Funds (ETFs) often have lower fees than mutual funds, and bond funds tend to be cheaper than equity funds. If you are considering a job switch, take the time to compare the 401(k) plans offered by your current and future employers. Larger plans often provide more cost-effective options, so staying with a low-fee 401(k) may be advantageous.

If you are still stuck with a 401(k) that has high fees, you must rethink how much you contribute. Maxing out a high-fee 401(k) could limit the growth of your investments. In such cases, it might be better to contribute enough to get your max 401(k) employer contribution match, if available, and then divert additional savings into alternatives like an IRA or HSA.

3. Traditional 401(k)s are taxed in retirement

Contributing to a traditional 401(k) has a clear tax advantage today. It lowers your taxable income for the year as you pay less in taxes right now. However, when you withdraw money from your 401(k) in retirement, those withdrawals will be taxed as regular income. So, if you have maxed out your traditional 401(k), you could face a larger tax bill in retirement. It is important to think about the long-term tax implications of maxing out a traditional 401(k). Paying taxes on a higher balance during retirement could reduce the amount of liquid money you have to cover your retirement needs.

Diversifying your investments is one way to balance your retirement savings and future tax liability. Instead of putting all your money into a traditional 401(k), you can consider contributing just enough to take full advantage of your employer’s match. Once you have the max 401(k) employer contribution match, you might want to focus on a Roth IRA. For example, if you have $15,000 to save for retirement this year, you could contribute $10,000 to your 401(k) to get the full employer match and put the remaining $5,000 into a Roth IRA. Contributions to a Roth IRA are made with after-tax dollars, so you will not get a tax break today, but the withdrawals in retirement, including both your contributions and any investment gains, will be tax-free. This strategy allows you to build a mix of taxable and tax-free retirement savings and ensures that you are not reliant on just your taxable withdrawals in retirement. Additionally, it also helps you diversify your retirement savings.

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4. Maxing out your 401(k) can compromise other financial goals

If you are maxing out your 401(k) and compromising other financial goals, you will be stuck with a poor financial plan that does not offer you all the backing you need. A poorly balanced financial plan that prioritizes only retirement savings might leave you unprepared for life’s other significant expenses. Retirement is undoubtedly important, and a 401(k) can help you get there. However, it comes with restrictions. Funds in a 401(k) are generally locked until age 59.5, and early withdrawals are subject to penalties and taxes. If you need to make a down payment on a house, fund your child’s education, or handle unexpected expenses, your 401(k) will not offer the liquidity you require.

This is why it is critical to create a balanced savings strategy that supports all your financial objectives. For instance, if buying a house is a priority, you could allocate a portion of your savings toward a brokerage account. Similarly, you can consider a 529 education plan for your child’s education, which offers tax advantages specifically designed for education costs.

Investing outside your 401(k) also brings other benefits, such as diversification. Investing across various asset classes, including stocks, bonds, and mutual funds, helps you reduce investment risk. Diversifying not only protects your savings but also opens the door for potentially higher growth. Creating a balanced plan ensures that you are better equipped to meet both short-term and long-term goals.

How much do I need to contribute to a 401(k) to max out?

To max out your 401(k), you need to contribute up to the annual limit set by the Internal Revenue Services (IRS). For 2025, the maximum contribution is $23,500 if you are under 50. If you are 50 or older, you can contribute an additional $7,500 as a catch-up contribution, bringing the total to $31,000. Additionally, those aged 60 to 63 can take advantage of a new provision allowing up to a $11,250 contribution. This replaces the standard $7,500 catch-up contribution.

Maxing out your 401(k) can be a smart move, especially if you are in a high tax bracket. However, calculating how much to contribute from each paycheck to reach the annual limit depends on your salary, financial goals, type of 401(k) account and other similar factors. You can use a 401(k)-contribution calculator to max out your investments and make informed decisions. It can also be helpful to consult with a financial advisor.   

How much should I contribute to my 401(k)?

While there is no fixed amount that suits everyone, you can analyze the following to arrive at a value:

1. Depending on your income

Your income can help you determine your 401(k) contribution. Ideally, you should aim to contribute as much as possible toward the IRS annual limit, which is $23,500 in 2025 for those under 50 and $31,000 for those over 50. However, maxing out may not be feasible for everyone.

For individuals with lower incomes or younger professionals just starting their careers, it is okay to start small. Contribute what you can comfortably afford, even if it is just 5% of your salary. Over time, you can gradually increase this amount as your income grows. A good rule of thumb is to increase your contribution by 1% to 2% each year. Additionally, the IRS adjusts the contribution limits annually, so you can increase your contributions accordingly.

2. Depending on the employer match

If your employer offers a match on your 401(k) contributions, it is crucial to take full advantage of it and make it a priority to contribute enough to your 401(k) to earn the entire match. The employer match is one of the best benefits of a 401(k), so you should not leave it on the table. You can contribute to an IRA after maxing out your 401(k). This can help you diversify your investments.

However, if there is no employer match, the decision becomes more about your financial priorities. In this case, you can evaluate your income and other financial goals, such as health needs, house ownership, debt reduction, etc., to determine how much you can afford to contribute to a 401(k).

In any case, if you are unsure about how much to contribute based on your personal financial situation, working with a financial advisor can help you find the right balance.

3. Depending on your future needs

Your future needs play a significant role in determining how much you should contribute to your retirement savings. Ideally, you should aim to have around 25 to 30 times your desired annual spending saved by the time you retire. This helps ensure that your retirement income will cover your living expenses for the long term. For example, if you want $50,000 annually in retirement income, you should aim to save between $1.25 million and $1.5 million by the time you retire.

However, your specific retirement needs may vary based on your lifestyle, health, age, and individual and family goals. A financial advisor can help you refine this estimate, taking into account factors like inflation and other potential sources of income in retirement.

To conclude

Maxing out your 401(k) contributions can be a smart strategy. However, this makes sense only in certain cases. If you have enough money after paying your bills, have adequate emergency savings, do not have high-interest debt, and have considered other tax-advantaged accounts like the IRA, HSA, etc., you can max out your 401(k). However, if you do not earn a high salary or if your 401(k) plan comes with high fees or limited investment options, it may not make financial sense to contribute the maximum amount. In such cases, it could be more beneficial to contribute enough to secure the employer match and then invest any additional savings into an IRA, which typically offers better funds and lower expenses. Evaluating your specific financial situation and consulting with a financial advisor can help you decide the right approach for achieving your long-term retirement goals.

Use the free advisor match tool to get matched with seasoned financial advisors who can help you decide on a suitable figure to contribute to your 401(k) based on your personal goals. Answer a few simple questions and get matched with 2 to 3 vetted financial advisors based on your requirements.

For further information on creating a suitable retirement plan for your unique financial requirements, visit Dash Investments or email me directly at dash@dashinvestments.com.

About Dash Investments

Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm, managing private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.

Dash Investments offers a full range of investment advisory and financial services, which are tailored to each client’s unique needs providing institutional-caliber money management services that are based upon a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.

CEO & Chief Investment Officer Jonathan Dash has been covered in major business publications such as Barron’s, The Wall Street Journal, and The New York Times as a leader in the investment industry with a track record of creating value for his firm’s clients.