Congratulations! You have successfully reached a significant financial milestone that many aspire to but few achieve: a maxed-out 401(k). This is a great achievement on your journey toward a secure retirement plan and should be celebrated.
However, you might be wondering, “Now what?” You’re not alone; many high-income Americans ponder the same question with a desire to make the best financial decisions.
In this guide, we’ll explore what it means to max out your 401(k), what to do when your 401(k) is maxed out, which key financial fundamentals to address, and where to invest next to supercharge your retirement account.
Understanding the Meaning of Maxing Out Your 401(k)
Before we begin, let’s first clarify what it truly means to max out your 401(k). Knowing what your 401(k) contribution limit is and understanding how your employer contributions could affect it are two of the most essential things to understand before you can move on to your next financial goals.
Contribution Limits
According to the Internal Revenue Service (IRS), for 2023, the maximum 401(k) contribution limit for those under 50 years old is $22,500. If you are age 50 or older, you're eligible to make catch-up contributions, specifically designed for those over 50, allowing an additional $7,500.
This brings the total allowable contribution for those 50 or older to $30,000. This limit exists for several reasons.
First, it ensures fairness and prevents the wealthiest of individuals from disproportionately benefiting from tax advantage.
Second, the limit promotes diversification of investments. When you reach your limit, you’re prompted to explore other investment avenues, which ultimately leads to a more balanced and diversified portfolio.
Employer Contributions
While your own contributions have annual limits set, it's crucial to note that employer contribution "limits" are determined by companies, not the government.
This means employer contributions don't count toward your personal limit. If you've been under-contributing, thinking your matching contributions (based on a certain percentage of your salary) affect your limit, rest assured it doesn't.
Your company’s policies on employer matches, often a part of their retirement benefits package, dictate these contributions. When you "max out" your 401k, it signifies your personal contributions have reached their limit, which can rise due to cost of living adjustments.
Depending on your age, this might also mean you've utilized any catch-up contributions. Remember, employer-sponsored contributions are essentially free money, enhancing your retirement savings.
Financial Fundamentals to Address First
In an ideal world, you have other basics within your financial plan covered before you're at the point of maxing out your 401(k), but once you are at that point, it's important to work with a professional to evaluate what else you might need to look at before you start to look for where or how to invest next. Tackle these first.
Emergency Funds
Before jumping into additional investments, always remember to build a robust emergency fund. Having around three to six months’ worth of living expenses safely tucked away in a high-yield savings account can provide you peace of mind.
These emergency funds will act as your safety net so you don’t have to tap into your retirement savings when things don’t go as planned. If you set up an emergency fund years ago and (thankfully) haven't needed to touch it, you might re-evaluate whether that amount is enough to cover possibly unexpected expenses.
The emergency fund you built up in your late 20s might not cover the expenses relevant to you in your 40s, even if it's been accruing interest in a high-yield savings account.
Appropriate Insurance Coverage
Protecting your wealth and loved ones is of utmost importance. It is advisable to always review your insurance coverage to ensure that you have at least enough or adequate life, disability, and health insurance.
With your emergency fund acting as a safety net and having appropriate insurance coverage serving as your safeguard, you can protect your finances in any type of unforeseen circumstances with ease.
A pro tip to those in a position to max out their 401(k): don't forget about disability coverage. It tends to be the forgotten coverage between life and health insurance, but an unexpected disability can hamper your income and savings potential through high-earning years, significantly impacting your ability to save for retirement, and thereby putting your overall financial plan at risk.
Working with a professional to evaluate your coverages and how they tie into your financial plan is key.
Limit "Bad" Debt
High-interest debt (such as credit card debt) is like an anchor on your potential financial progress. If you’re carrying a huge load of bad debt and you’re also shouldering a high interest rate, you should consider prioritizing debt repayment first.
Paying off high-interest debt is an effective investment of its own and can provide an excellent return on your money. If you're curious to learn more about what debt could be considered bad within your own plan, check out our article outlining good vs. bad debt.
What to Invest In Next to Supercharge Your Retirement
Now that you have confirmed you are truly maxing out your 401(k) contributions and addressed your financial fundamentals, you can now explore new investment avenues with confidence.
1. Traditional IRA
You may consider opening a Traditional Individual Retirement Account (Traditional IRA).
Just like the 401(k), a Traditional IRA mirrors its provision of pre-tax benefits. This could bring financial benefits in the present.
It's important to note that though your investment accrues without being taxed now, the withdrawals you make after retiring will be taxed. Sometimes, withdrawing significant amounts in retirement could make you liable for higher tax rates than those that apply to your current earnings.
Consequently, it's not fully considered as "free" money. Given the complexities, consulting a professional can be invaluable in determining how to best allocate your funds.
Additionally, be aware of income limits when deducting contributions if you're already covered by a retirement plan at work.
2. Roth IRA
Another excellent option is a Roth Individual Retirement Account. Compared to a traditional IRA, the downsides of contributions to a Roth IRA account are not tax-deductible, but the big advantage comes during retirement.
Withdrawals from a Roth IRA in retirement are completely tax-free, including any capital gains, such as those from mutual funds. This technically means that you’re contributing with after-tax dollars, and future withdrawals are not to be subjected to taxation.
Depending on your current income and projected retirement income, this strategy can be especially beneficial, particularly early in your savings journey when your tax rate is likely lower. This offers a path to a tax-efficient retirement plan.
3. Investments With a Professional
Starting additional investment accounts can sometimes be complicated, but take note that these are not mutually exclusive from your 401(k) and IRAs.
Here's why consulting with a financial advisor can be helpful when taking your next steps:
When you work with a professional like Plancorp, we will not just help you in opening and contributing to IRA-like accounts but also in managing asset distribution and diversification.
Our group of consultants can lead you toward the most appropriate investment choices that align with your financial objectives while considering your risk tolerance.
4. Health Savings Account (HSA)
If you have access to a High Deductible Health Plan (HDHP), you may consider opening a Health Savings Account (HSA).
HSAs offer a unique triple tax advantage with contributions being tax-deductible, earnings growing tax-free, and withdrawals that are qualified as health care expenses are tax-free. Plus, if you’re older than 65, you can withdraw funds for non-medical expenses completely penalty-free.
Put simply, Health Savings Accounts can be a secret weapon in supercharging your retirement plan by allowing you to save, grow, and spend money specifically for healthcare tax-free, something invaluable as healthcare costs continue to rise.
Take The Next Steps For Your Retirement Planning
Maxing out your 401(k) is indeed a remarkable achievement, in fact, according to a 2021 Vanguard report on "How America Saves" only 14% of workers contributed the maximum allowable amount.
But your retirement savings journey doesn’t end there, especially if you are in peak earning years. It only signifies that you’re on the right track, and there are additional financial fronts to conquer and a variety of investment opportunities to explore to fuel a secure retirement or longer-term legacy for your family.
The above steps are great, but remember everyone’s financial situation is unique, and there’s no one-size-fits-all answer to what you should specifically do after your 401(k) maxed out.
This crossroads is where the Plancorp team can significantly change your path and can help you build a customized plan. We understand the intricacies of financial planning while considering your preferences and risk tolerance.
Our main goal is to guide you on the path to a secure retirement. Don’t hesitate to reach out to us today and take the next steps toward a brighter financial future. Your ideal retirement is within reach, and we’re here to help you achieve it.
