How to Max Out Your 401(k)

One of the most common ways of preparing for retirement is through a 401(k), a tax-advantaged account offered by employers which helps to set aside funds for your use after retiring.

To get the most out of a 401(k), investors should be aware of contribution limits and rules set by the Internal Revenue Service (IRS). They should also understand the advantages of employer matching programs, strategies for allocating their excess income to the account, and additional retirement savings options. 

Each year, individuals eligible for 401(k)s are able to set aside as much money as they would like toward those plans, up to a limit fixed by the IRS. For 2024, the IRS allows individuals to contribute up to $23,000 to a 401(k).

For those with plenty of time until retirement—such as investors in the millennial generation—the power of compounding offers the possibility of achieving significant retirement funds, although it’s key to begin as soon as possible. 

Here, we explore how to maximize a 401(k), the advantages of doing so, and what to do with any additional money you’d like to set aside for retirement.

Increase Contributions Gradually

In order to maximize 401(k) contributions each year, it’s helpful to aim to reach the limit. However, many millennials may find that this is not possible, particularly given the generation’s high student debt burden, increased costs of care for children and aging relatives, and widespread inflation, among other factors.

If you find yourself in this position, consider beginning with a regular contribution that feels manageable within your current budget and aim to increase that contribution gradually over time. 

Experts suggest that increasing retirement contributions by 1% of your annual salary can yield tens of thousands of dollars more in a retirement account by the time you retire. You might also consider automatically upping your 401(k) contribution if you get a raise or a bonus.

Check the Default Rate

Because you enroll in a 401(k) as part of your job and this often takes place shortly after you begin work, it can be easy to miss out on important details that can lead to additional retirement contributions when you’re getting set up. 

For example, some 401(k)s will automatically set aside a set percentage of your pay for retirement—the default rate. This is helpful, but typically that percentage is not the maximum you can contribute. Be sure to read any documents pertaining to your 401(k) and enrollment carefully to ensure you take full advantage.

Get the Employer Matches

Another bit of fine print to read especially carefully as you sign up for a 401(k) relates to whether (and how much) your employer will contribute. Many employers offer to match your contributions up to a certain percentage of your salary—typically 3% to 6%. To get the full match, you have to contribute that percentage, too. 

Investors should take advantage of this opportunity whenever possible, as it represents free money to set aside toward retirement and does not impact the maximum contribution you can make. These contributions grow tax-free and are only taxed when withdrawn from the 401(k).

Be mindful, however, that employers may have a vesting requirement for any contributions made on your behalf to a retirement plan. You may have to remain employed at the company until vested (typically a period of several years) in order to be able to keep the employer match funds.

Beware of Early Withdrawal Penalties

Millennials are the most likely generation to switch jobs, with almost a quarter saying they’ve changed jobs in the past year.

With each job change come some important decisions about pre-existing retirement savings. Don’t be tempted to spend cash in an old retirement account unless it’s absolutely necessary, as you’ll pay an early withdrawal penalty tax and fail to benefit from the power of compounding on funds held in a retirement account for many additional years. 

Instead, rollover your retirement savings to your new employer’s plan to benefit from having one account to manage or to an IRA to access new investment options.

Become an Informed Investor

Employer-sponsored plans have defined contribution limits that you need to actively manage to strategically build up savings, while pensions are managed by someone else and offer defined benefits.

Financial planner Chad Kennedy, MJ, of Lighthouse Financial notes that “401(k) plans differ greatly from the pension plans that millennials’ parents often utilized in previous decades. 401(k) plans require the employee to direct the investments within the retirement account, while a pension plan’s investments are managed by the employer or a third-party money manager.” 

Kennedy adds that, though daunting, the responsibility of managing your own 401(k) provides a “great opportunity to optimize the retirement account to suit your own financial goals.” 

Doing so requires that you become well-versed in the different ways of structuring your 401(k) investments. Here are a few tips to keep in mind:

• You can take as active an approach as you like: 401(k)s allow investors to put all of their investments in a target date or growth fund for a passive investing experience, or to actively manage a portfolio including a range of different securities. The choice is up to you.
• Different providers, different options: Your choices of what to include in your 401(k) portfolio may be limited by the provider. It pays to research what that provider offers before planning out any investment decisions.
• Balance stocks and bonds: One of the cardinal rules of retirement planning is to adopt a more conservative investment approach the closer one gets to retirement. The reason for this is that, if your investments are tied to volatile assets like stocks and there happens to be a downturn right before you retire, you stand to lose a large chunk of what you’ve spent decades saving. At this point, most millennial investors will opt for a higher-risk, higher-reward asset allocation that is weighted more heavily toward stocks. As time goes on and retirement gets closer, this may shift toward a more bond-heavy approach.

Benefits of Maxing Out Your 401(k)

One of the key benefits of maxing out your 401(k) contributions is that it allows you to take advantage of compound interest. The earlier that you add money to your 401(k), the longer that money has the chance to earn interest—and the longer the interest you earn has a chance to earn more interest.

As mentioned above, maxing out your 401(k) contributions each year ensures that you’ll be able to take full advantage of any employer match which is available to you, essentially earning you free money to put into the plan.

For millennials who have reached or are approaching their peak earning years, it may be advantageous from a tax perspective now to maximize contributions to a traditional 401(k). 

Millennials expecting to see increases in salary throughout the remainder of their careers may look to a Roth option to take better advantage of the tax implications. Roth retirement accounts are funded with post-tax income, meaning that any contributions made now will be taxed at your current tax rate.

If you anticipate your salary (and tax bracket) to increase over time, a Roth 401(k) allows you to withdraw funds during retirement without having to pay taxes at that higher rate.

What to Do After Maxing Out Your 401(k)

You’ve maximized your contributions to your 401(k) and taken full advantage of any employer match that is available to you. Here are some of the options you might consider for further retirement savings at this point:

• Individual retirement accounts: IRAs are retirement accounts open to individuals through a brokerage or fund manager (as opposed to 401(k)s, available only through employers). They exist in both traditional and Roth formats for millennials to maximize tax advantages. The 2024 contribution limit for an IRA is $7,000.
• Health savings accounts: HSAs allow you to set aside pre-tax income to pay for certain medical expenses, potentially allowing you to reduce the total out-of-pocket costs. Eligibility for an HSA depends on your healthcare plan.
• Variable annuities: Variable annuities are contracts between investors and insurance companies. Through an annuity, the investor supplies a purchase payment (either all at once or spread out over multiple installments) and the insurer agrees to make periodic payments back to the investor either immediately or beginning at some point in the future. The latter of these options, called a deferred annuity, may be the best option for those seeking to boost their retirement savings.
• Taxable investments: Taxable brokerage accounts do not receive the same tax advantages as 401(k)s or IRAs. However, depending upon your returns over time, these accounts may still provide a strong alternative option.

Evaluating these options will likely include an assessment of how much additional income you’re comfortable putting toward retirement after maxing out your 401(k). 

Finally, some of the options above, such as a taxable brokerage account, may require a more active approach to investing, while others are more passive.

The Bottom Line

There are significant long-term benefits to maximizing your 401(k) contributions, including greater funds available in retirement, taking advantage of compound interest, and more. Gradually increasing your contributions over time can help you to eventually be able to max them out. 

Once you have, you can put any additional funds you’d like to set toward retirement into IRAs, HSAs, annuities, or taxable investment accounts. Your decision about these post-maxing-out strategies will depend on your risk tolerance, investment goals, time horizon, and more.