Why You Shouldn't Max Your 401(k)

https://ofdollarsanddata.com/should-i-max-out-my-401k/

22 30 6 years ago

For 99% of people having money that is a) difficult to touch and b) never shows up in your bank account is actually an order of magnitude (or two) more important for retirement than 0.34% annualized return.

And his point on which path to take misses the point that for some people (and me at least) - my "annual pay" when I'm retired will be 50% or less than what I make now. When I'm not paying a mortgage, paying for college, or saving for retirement I'll need much less pay. Can I predict what the tax rate will be in 20 years at half my current pay? No. So I hedge and do both options.

toomuchtodo5• 6 years ago

401ks are federally protected from creditors. If you’ve maxed your IRA(s), and you have discretionary income you want to invest further, it absolutely makes sense to fully fund your 401k annually. Yes, the funds are tied up but they’re also protected against most creditors and judgements.

With that said, the vast majority of Americans would be better served with the 401k being deprecated, IRA limits increased, and IRAs receiving the creditor protection at the federal level 401ks currently have. This eliminates the need for employers to sponsor a 401k plan; an IRA is as easy as opening an account with any discount brokerage (which there are many of). This also eliminates the captive audience problem where 401k plans have higher expense ratios than investment options available in IRA or taxable accounts.

fred_is_fred4• 6 years ago

Creditor protection is a good point, and as for IRAs - Lots of people who read Hacker News can't contribute at all due to income limits.

My serious worry is that if the average American follows this advice they will lease a new car every 2 years and go to Hawaii every year - and when they are 65 will all want a retirement bailout from people who actually saved money. There's nothing preventing Congress from deciding to tax Roth in 20 years in this scenario.

paxys• 6 years ago

This also eliminates the captive audience problem where 401k plans have higher expense ratios than investment options available in IRA or taxable accounts.

This isn't true across the board. Large employers get great rates for their 401k funds due to the collective size of investment, better than anything available to an individual. This is similar to employer sponsored health coverage, and the reason both of them won't go away anytime soon.

JMTQp8lwXL• 6 years ago

I would agree with the second half if you could set up automatic paycheck transfers to your IRA from your employer. It has to be that easy, in order for people to save.

Going from your checking account to your IRA brokerage is something only financially savvy people do. You have to make it as easy as possible for retirement savings to happen, and it's totally within the government's interest to ensure people save money for old age when they can't work: it means less reliance on Social Security.

jackdeansmith• 6 years ago

This article makes a major mistake when addressing the benefits of a traditional 401k. When you contribute, you avoid paying taxes at your marginal rate and when you withdraw (for most people at least, who will fund their retirement primarily through 401k withdraw) you pay taxes at your overall rate. The article also treats tax uncertainty as if it only applies to income taxes while it's completely plausible that taxes on capital gains could be increased in the future as well.

js22• 6 years ago

The article mentioned the last point:

I understand that you can make the same argument about taxable accounts and a rising capital gains rate. However, I would bet that capital gains rates will remain below ordinary income rates for the foreseeable future.

aeternum• 6 years ago

Aren't 401k withdrawals still taxed as ordinary income? Therefore part or all of it could still be taxed at your marginal rate during retirement, it's just that the marginal rate should in theory be lower during retirement since you have less income.

smcg• 6 years ago

Not a big fan of this headline. Everyone should maximize their employee match. Going up to the max yearly contribution is slightly inefficient, but the few who can afford this already know that.

gmadsen• 6 years ago

inefficient in what way? after you meet company match, max out an ira, then what would you do instead of maxing out the 401k? The tax savings are a big deal.

whateveracct• 6 years ago

The tax savings are a big deal.

Seriously - where else can you instantly make dollars worth more than $1?

js22• 6 years ago

One point I don't see mentioned is that in most cases, 401(k)'s are protected during bankruptcy.

https://www.nolo.com/legal-encyclopedia/retirement-plan-bank...

mox1• 6 years ago

Not just during bankruptcy, but overall a 401(k) and similar retirement plans that fall under ERISA* rules are pretty heavily protected from creditors (besides the IRS).

Something to consider if you plan on going into a risky area of business in the future.

  1. Retirement accounts that qualify under the Employee Retirement Income Security Act (ERISA) are generally protected from creditors, bankruptcy proceedings and civil lawsuits.

dkural• 6 years ago

Oh wow! So a major downside of saving money for the future is, I don't get to spend it now huh? What an eye-opener.

abstractbarista• 6 years ago

This article seems a bit simplistic. It really depends on whether your current and near-future tax rate is less than your tax rate in retirement. Consider that politically, taxes may be lower now than they will be in 30 years. Your tax rate typically increases as you progress in an industry.

In my case, I max out a 401k that is split 2/3 Roth, 1/3 Traditional. I also max out a Roth IRA every year. Additionally, I'm stuffing all excess cash in a taxable brokerage account. The taxable account is growing faster than the Roth IRA because I'm limiting discretionary spending and buying equities whenever I have extra cash.

I expect my tax rate to be higher in retirement since I'm saving like crazy as a 25 year old (and have been for years already) and expect to continue to do so for decades.

(I wouldn't even be surprised if some politicians decide to bludgeon me for being a responsible saver by voiding the tax-free withdrawals of Roths in the future. But that's a bit paranoid and hopefully won't happen.)

oxfeed65261• 6 years ago

As a person of more modest means, I hope that it will happen. Hoarding your own money is not, in any meaningful sense, “responsible.”

floor2• 6 years ago

I really wish people would stop using ridiculous hyperbole like "hoarding" when describing "a middle-class person saving for a future emergency or retirement".

For starters, in the modern economy, the notion of "hoarding" is mostly antiquated - people aren't storing their wealth by keeping a silo full of grain (which might overall benefit society by being distributed to the hungry now) but instead by owning shares of the business that provide the goods, services and employment that keep society working and allow everyone to live a modern life instead of being hunter-gatherers.

The worker who is maxing out their 401k is not your enemy.

sidhanthp• 6 years ago

Doesn't the option to withdraw your 401k exist with a 10% penalty (+ taxes)?

If you're including employer match here, it looks like you can still get instant, guaranteed gain.

junar• 6 years ago

This article uses tax estimates that are likely too low for many who can possibly max a 401k.

It doesn't mention state income tax at all, despite the vast majority of states having one. It doesn't mention that funds can distribute interest and non-qualified dividends, which are taxed at the regular federal rates. It doesn't mention the 20% qualified-dividends-capital-gains rates or the Net Investment Income Tax, which further impact high earners.

In short, most people should do their own analysis because this analysis is not going to be accurate for them.

Why You Shouldn't Max Your 401(k)

Related Stories