The magic number for those planning to max out their 401(k)s this year is $19,500, though those 50 and older can bump this up to $26,000. It’s a lofty goal, but reaching it can go a long way toward setting you up for a comfortable retirement. You’re probably trying to figure out how you’re going to save that much, but that’s not the only question you should be asking yourself. Here are a few other things you need to keep in mind.
1. The limitations on accessing your 401(k) funds
You usually can’t withdraw funds from your 401(k) before age 59 1/2 without paying an early withdrawal penalty. The government waived this for 2020 so people affected by the pandemic can use their savings to help them cover essential expenses, but this limitation is likely going to come back at some point.
Once it does, you can only make early withdrawals penalty-free if you qualify for an exception. Things like large medical expenses, first home purchases, and disability qualify as exceptions. You can also make Substantially Equal Periodic Payments (SEPPs) where you withdraw regular amounts annually from your 401(k) for the longer of five years or until you turn 59 1/2.
If you’re already over 59 1/2 or you have no intention of using your money before then, the restrictions on 401(k) withdrawals won’t bother you. But if you plan to retire before 59 1/2 or believe you may need to withdraw some of your savings to cover emergency expenses, you could run into these penalties.
Come up with a backup plan now so you can avoid them. That could involve SEPPs or storing some of your savings in a high-yield savings account or taxable brokerage account rather than your 401(k), so you can access it at any time.
2. How much you’ve already contributed
Keep a close eye on how much you’ve already contributed to your 401(k) this year to make sure you don’t exceed the annual contribution limits. Doing so will cause you to pay taxes on your savings twice unless you withdraw the excess and any earnings associated with it before the tax deadline for the year.
You can find out how much you’ve already contributed to your 401(k) by looking in your online 401(k) account, if you have one. This information might also be listed on your paystubs. Check with your company’s Human Resources department if you’re not sure where to find it.
Remember, the contribution limits apply to all of your 401(k) accounts, not to each one individually. So if your company offers you a traditional 401(k) and a Roth 401(k), your combined contributions may not exceed $19,500, or $26,000 if you’re 50 or older.
3. If a 401(k) is the best home for your money
A 401(k) is an attractive place for your savings, particularly if your employer matches some of your contributions. But it’s not always your best option. Some 401(k)s charge high fees and offer you few investment choices. This can hamper the growth of your savings, especially if you’re not getting a match or any assistance with fees from your employer.
In that case, you’re better off putting your retirement savings in an IRA first. You can choose any brokerage and just about any investment you want, so you have a lot more control over what you’re paying in fees. The downside is that you’re only allowed to contribute up to $6,000 to an IRA in 2020, or $7,000 if you’re 50 or older. If you max that out and have extra savings, return to your 401(k).
Even if you are getting a 401(k) match, consider how long you’ll be with your company to decide if it’s worth it. Companies usually have a vesting schedule that decides how long you must work for the company in order to keep your employer-matched funds if you leave. Quitting your job before you’re fully vested could cost you some or all of your match. It’s not something you have to worry about if you’ve already been with your employer for a decade, but if you’re new and you don’t see a future there, focus on the fees and investment options when deciding whether a 401(k) is right for you. And if you have any questions about the company’s vesting schedule, ask your HR department.
Saving for retirement is a good thing, but blindly sticking money into a retirement account without considering the implications on your budget and tax bill isn’t wise. Before you contribute any more money to your 401(k) this year, review the above information to decide if that’s the best use of your dollars right now.