Maxing out your 401k: Supercharge your Retirement Savings

If you have access to a 401k from your employer, consider yourself lucky. According to this article, 35% of private sector workers don't have access to a 401k account.

This fact is a shame because contributing to a 401k is a great way to build your retirement nest egg.

If you do have access to a 401k and have enough margin in maxing out your yearly contribution, this is a fantastic way to supercharge your retirement funds. Even if you can't fully max your 401k based on where you are at financially right now, understanding the power it provides can help you make informed financial decisions in the future.

Getting to a Spot where Maxing out My 401k Makes Sense

It makes sense to contribute to your 401k in most cases to get the match, even when you are in debt. But I wouldn't suggest maxing out your 401k until at least your credit cards are paid off (and possibly other debts like student loans, car loans, etc.).

The main reason is your credit cards will most likely charge a much higher interest rate than what you can earn from your 401k.

By waiting for the right time to go heavy into your 401k, you allow yourself to pay off your debts faster, and your net worth will increase at a faster rate.

I know it can be tempting to ignore your consumer debt and focus on your 401k. But usually, this is based on 100% emotions and not what is best for your financial future. Even if you can only meet the match, you will see these numbers add up over time.

I'm kicking myself for not contributing at least enough to get my full 401k match while I was employed. Meeting the match would have made my 401k balance multiple 5-figures larger.

Think of maxing out your 401k as a celebration for when you get consumer debt free, and what you've accomplished in your career.

The Main Benefits of Maxing Out Your 401k

The biggest advantage of contributing to your 401k are the following:

  • If your employer has a match, this is free money towards your retirement years.
  • 401k contributions lower the amount of taxes you owe in the current year.

Even if you are considering retiring before the typical 65 years-old age, this is money that will grow over time and can help fund your retirement in your later years.

Employer Match

If you make $50,000/year, and your employer matches the first 3%, this equates to a free $1,500/year! Every time you get a raise, the amount you get from your employer goes up. It's like getting two raises: one for your paycheck, and another for your retirement!

This reason is why I highly suggest hitting your match, even while you are in debt. You are getting a 100% return on this money, and it is going to help build your 401k balance faster.

As long I have a job that provides a 401k and a match, I'm dedicated to meeting the match at a minimum.

401k Tax Benefits

By contributing to your 401k, your tax burden for the year goes down.

Does this money end up being tax-free? No. It just changes when you pay taxes on that amount.

If you don't max out your 401k, you will pay taxes on the $19,000 you would have contributed right away. If you are in the 24% federal tax bracket (which can change in the future) and make $100,000/year, that will save you $4,560 in taxes that year.

The tax benefits are partially why your take-home pay doesn't go down 100% of what you end up contributing to your 401k. If you contribute $1,000/mo to your 401k, your paycheck will only decrease by $760 (assuming you are in the 24% tax bracket). You should also save on state taxes, as these funds usually aren't taxed for most states until the money is taken out of the 401k.

A big part of the benefit with a 401k is if you will end up being in a lower tax bracket by the time you pull out the money in retirement. I think this has a good chance of being true for most people, but that might not be true for everyone. For example, if you are building up several passive/semi-passive income streams, you might end up being in a higher tax bracket by the time you retire.

In my case, since I am not sure exactly where we will land in retirement, we are going to max out our 401k and also max out our Roth IRA every year going forward. This plan gives us some tax diversification. The worst case is we end up paying a little more in taxes on our 401k funds in the future, but we still get the tax benefits today.

Max 401k Numbers

As of writing this article, the max you can contribute to a 401k is $19,000, up to 100% of your income. If you are at least 50 years old, you can contribute an additional $6,000 per year as part of your catch-up contribution ($25,000 total). I suggest checking the current years' limits to see if these numbers have increased.

The beauty of maxing out my 401k is that we also get a match from my employer, which DOES NOT count towards our contribution limits.

If you have access to multiple 401k accounts, or small business retirement accounts (like SEP, SIMPLE IRA), you will want to make sure you keep the maximum yearly allocation amount in mind. As of writing this article, that is a total of $59,000/year (which is in addition to the catch-up contribution amount when you are at least 50-years old).

Here are how the numbers look after 20 years, assuming you hit the $19,000/year max. Note that this does not include the catch-up contribution of $6,000 you can start making when you are at least 50 years old. We also assume an employer match of 4%.

Keep in mind this data is based on an annualized return of 8%, and that each year the 401k max contribution + match applies. This data also assumes you don't get any raises during this time.

Do not depend on these numbers; they are meant to only be used as rough estimates. Markets will fluctuate, and some years you might have a negative return. These numbers are based on historical averages and can vary greatly depending on where you are at in the market cycle. Past returns are not a guarantee of future returns.

Year #Total
Year #1$24,000
Year #2$50,000
Year #3$78,000
Year #4$108,000
Year #5$141,000
Year #6$176,000
Year #7$215,000
Year #8$256,000
Year #9$302,000
Year #10$351,000
Year #11$404,000
Year #12$461,000
Year #13$523,000
Year #14$590,000
Year #15$663,000
Year #16$742,000
Year #17$827,000
Year #18$920,000
Year #19$1,020,000
Year #20$1,129,000

Below is a full graph showing the numbers over a period of 20 years.

Growth rate when you max out your 401k

Maxing Out Your 401k is a Great Example of Compound Interest

The earlier you start contributing to your 401k, the faster the balance should grow over time.

When you do start maxing out your 401k, you tap into the power of compound interest. Every year you can contribute the maximum amount to your 401k, the more opportunity you have in generating more value from appreciation and dividend growth.

Depending on how high the employer match is, your earnings should end up exceeding the total amount you contribute after around 10-years. Hopefully, over time, you will also receive raises, which will help with the growth of your 401k.

As you can see from the table and graph above, your 401k balance starts to get into some serious numbers after a few years. After around the 20-year mark, assuming a 4% employer match, you might have over $1,000,000 in your 401k! This amount will depend on what the market does during this time frame. But in most cases, you should have a massive 401k balance.

Forced Scarcity

By contributing to your 401k, your paycheck amount will go down.

Contributing to your 401k is a double-edged sword because it immediately feels like you are making less money. But you are actually putting a big chunk of your retirement savings on autopilot.

Once you get used to budgeting the new paycheck amount, you won't even feel like you are making less money. It's one way you can pay yourself first to supercharge your finances. From that point on, raises will mostly show up in your paycheck (outside of taxes), while you still end up hitting the max + the additional employer 401k match.

The hard part is getting to a spot where you can comfortably live off of your reduced paycheck.

What if you can't afford to max out your 401k?

It would be naive for me to think that everyone is going to be able to max out their 401k contribution easily. The reality is, $19,000 is a lot of money if that is 50% or more of your total income from that job.

The more you make, the easier it becomes in absorbing that $19,000 max amount.

If you are not at the point where you can cut your paycheck by the maximum amount, figure out what makes sense and give that a try.

Being able to max out your 401k means that you probably have a high income that allows you to make those kinds of cuts in your budget and still be reasonably comfortable.

If you are married, and both of you work, that increases the chance that eventually you might be able to do this more easily.

Don't feel bad if you can't max out your 401k right away. Just do what you can, and try not to compare yourself to what other people can do. We all make different amounts of money, with different priorities, and the goal should be saving as much as you can for your financial future.

Time is the Most Valuable Aspect of Your 401k

The sooner you can contribute to your 401k in any capacity, the longer it has to grow over time.

It's hard to contribute more to make up what 10-years will do with your money, even with a much smaller contribution.

I'm going to repeat this idea because I think it is so important. But this is one reason you should try to always hit your employer 401k match (if you have one). You double the impact of your contribution and raises, and it increases your growth rate.

The reason I didn't meet my 401k employer match in the past was because I was constantly hyper-focused on paying down our consumer debt. I didn't want to lower the amount I received from my paycheck for any reason, and now I'm faced with the consequences of that decision. Is it going to ruin our financial future in retirement? Probably not, but it is one of my most significant financial mistakes.

Not Many People Contribute to Their 401k

According to this CNBC article, the average 401k account balance is around $18,000.

This means that if you can start contributing a significant amount, and do so over multiple years, you will be ahead of most people.

Part of it might be because some companies don't have a 401k, or don't offer an employer match. But in either case, most people aren't thinking about their retirement years early in their careers. By the time they get older, they will have permanently lost all the time their money could have been growing.

Even if you aren't at a spot where you can contribute to your 401k, being cognitive of doing so in the future is a smart move. A few years isn't going to hurt you too much, but multiple decades? That cost is going to sting much more.

Contributing and maxing out your 401k is one way to set yourself up in reaching your financial goals for retirement. It reduces the amount of taxes you pay now, and if you are multiple decades away from reaching full retirement age, this is money that can start growing drastically because of compound interest.

Since we are starting our retirement savings in our mid-30's, we can't only depend on our 401k. We need to increase our income and net-worth in additional ways, like expanding our salon and possibly putting money into an after-tax investment account.

But being able to max out our 401k contribution is a big win for us. If we can continue this pace, we should increase the chances of being in a very strong financial spot in the future.

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