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Maxing Out 401(K): Why & When You Should?

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If you have access to an employer-sponsored 401(k), you can opt to put away a certain amount of your paycheck directly to your 401(k). And if your employer matches your contributions up to a certain percentage or dollar amount, it would be foolish to turn down what’s essentially free money.

For 2021, if you want to max out your 401(k), you need to contribute $19,500 each year —or $26,000 if you are age 50 and above. Here’s what you need to know about maxing out a 401(k):

When to Max Out Your 401(k)?

You should consider maxing out your yearly contribution if you can afford it and if it doesn’t hamper your budget. If your annual income is $140,000 in 2021, and if your current finances are in order, you would be able to max out your contribution of $19,500 comfortably.

Some financial experts recommend saving at least 15% of your annual income for retirement every working year throughout your career. However, this is general advice. The right amount you should be putting away for retirement depends on the following:

  • When you plan to retire?
  • How much have you saved up till now?
  • What might your lifestyle look like in retirement?
  • How much money you need every month to sustain that lifestyle?

Once you have made a rough estimate of your target amount, work backward to determine how much you should contribute towards your 401(k) to meet your target.

You can also contribute the minimum to get the benefit of an employer’s 401(k). This way, you can take advantage of the employer match as that’s free money on the table.

Moreover, the yearly contributions you make aren’t only helping you save for retirement; they also lower your taxable income for that year, thus providing immediate tax benefit.

401(k) Employer Matching Contributions

Employers offering 401(k) plans to their employees even match their contributions to attract and retain the employees. Some employers match

  • 50% of your contribution, or
  • dollar-for-dollar match up to a certain limit.

When you max out your 401(k) savings, your company matches a certain percentage for every dollar you contribute to your 410(k). This increases the money saved in the account.

Where to Invest Once You Max Out Your 401(k)?

If you are contributing the maximum to your 401(k) plans, you can augment your retirement savings with several different investment vehicles as follows:

  1. Traditional IRA Income Limits:If you are covered by a retirement plan at work, traditional IRA contribution deduction depends on the income slabs you belong to. For 2021, if you are a single taxpayer, the deduction phase-out begins at a modified adjusted gross income (MAGI) of $66,000 and completely goes away if your MAGI is $76,000 and above. If you are married and filing jointly, and your spouse contributing to an IRA has a workplace retirement plan, the deduction phase-out begins at $105,000 and completely goes away at $125,000. If you don’t qualify for part or full deduction of your traditional IRA contribution, you can make a contribution up to the contribution limit, and your investment will still grow on a tax-deferred basis.
  2. Individual Retirement Accounts (IRAs):In 2021, you can make contributions of up to $6,000 to an IRA or $7,000 if you’re age 50 and above. However, some IRA options may have a few income restrictions.
  3. Roth IRA Income Limits:For 2021, if you are single taxpayers, the income phase-out begins at a MAGI of $125,000 and goes away for income of $140,000 and above. If you are married and filing jointly, the phase-out starts at a MAGI of $198,000 and goes away at a MAGI of $208,000.
  4. HSA Accounts:Health savings accounts (HSAs) are available to individuals with high-deductible health plans (HDHPs), irrespective of whether they got it through their employers or purchased it on their own. For 2021, the contribution limits for an individual is $3,600 and for a family is $7,200. If you are age 55 and above, the catch-up contribution is an additional $1,000. Contributions are made on a pre-tax basis.
  5. Variable Annuities:In variable annuities, after-tax contributions grow on a tax-deferred basis. The contract owner can decide to redeem the contract partially or fully or annuitize it. However, the gains are treated as ordinary income and hence taxed.

Key Takeaways

  • Max out your 401(k) each year and take the benefit of the employer match.
  • Contributions are tax-deductible, leaving you more money to save or invest.
  • After you max out your 401(k), consider investing the leftover money into an HSA, IRA, annuity, or taxable account.