Most personal finance experts recommend contributing to the 401K up to the match. Even without a match, the plan provides a fairly easy way to automate your savings while lowering your taxes. With open enrollment approaching at my job, I’m faced with the question: Should I max out my 401K? When I first got this position, I set a goal to contribute $16,500, the maximum possible. Now, that figure seems a bit intimidating. Spread over 6 months, $16,500 will be $2,750 per month, or more than a majority of my monthly paycheck.
Why I should NOT max out my 401K:
- $16,500 is a lot of money to be tying up – I may very well need money for a new car, graduate school tuition, big moving expenses, etc. in the next 1-5 years
- The next open enrollment period is January 2011, so basically once I set my contributions, I’m locked in. I can’t decide in September that I’d like to scale back.
- I don’t have an employer match
- I can access lower expense ratios in my Rollover IRA / Roth IRAs
Why I SHOULD max out my 401K:
- There is no better way of enforced savings. Truly. 401K contributions come out before Federal Income tax, for goodness sakes. You know how Uncle Sam always gets his money where it’s due? Well, maybe it’s time for Auntie Retirement to get hers too.
- Lower taxes. Right now, about 28% of my paycheck is gone before the money even hit my checking account. Maxing out my 401K will dramatically reduce my Federal income tax.
- I will be very thankful that I maxed out 401K if I go back to graduate school in a few years. An MBA comes with big loans, not tax-deferred retirement vehicles.
- On a related note, the next 5 years will likely be filled with a lot of moving pieces, both personally and professionally. Hopefully I will be earning a higher salary in 5 years, but I will also have more personal obligations (some possible big expenses that come to mind are: wedding/honeymoon, grad school, new car, cross-country relocation, etc). So it’s probably wise to save as much as I can right now.
- I didn’t have a 401K for 2008. So really I’m only saving $8,250 a year if you spread the contribution over 2008 and 2010.
- When I roll over my contributions, I can invest the money in a much wider variety of funds. But I have to have the money in a 401K first before I can roll anything over.
So.. there you have it. I have until June 30th to make a decision. A reasonable suggestion might be to contribute $10,000 to the 401K, but I admit I really like the sound of maxing out 401K! I have been saving for the past couple of month in an savings account that I dubbed the “cash-flow subsidy account” to supplement my paycheck for the rest of the year. I have enough cash savings so that even if my car dies tomorrow (knock on wood!), I can buy a new economy car or a 2nd hand Honda and my emergency fund will still be in fairly decent shape.