Conventional personal finance wisdom often instructs one to make full use of tax-advantaged accounts before placing additional savings into other investments.

I don't think this is bad advice in general, but I suspect it is informed by the individual 401k maximum contribution ($19,500 as of 2020).

My employer allows for employees to request that their salary be reduced and instead have that amount contributed (by the employer) into the employee's 401k (up to the $57,000 limit for combined employee and employer contributions).

Are there enough advantages to 401k tax deferral that I should really maximize this before saving/investing on my own? My concern is that I'll find myself "401k-poor" - with more than enough saved for retirement, but not having ready access to funds for things like house down payments and college expenses.

I'm in my 30s and my 401k balance seems to be "on track" in terms of retirement savings even with 401k contributions of less than $57,000 per year.

  • I suspect the employer offers it because it might reduce their tax obligation (assuming their contributions are not subject to payroll tax). Whether doing this benefits you depends on what your tax bracket is now and what you think it would be when you withdraw funds. – chepner Oct 22 at 17:32
  • Do they allow you do this even if you haven't maxed out the individual 401k contribution? Or do you have to max out the 19500 first and then you can "convert" salary into employer contributions? – TTT Oct 22 at 18:23
  • That is a really cool perk that your employer provides. I don't think anyone can provide a good answer because it completely depends on your personal situation which you haven't told us much about. If you are saving money for another purpose (e.g., buy a house) then don't add more to your 401k. If you are just investing the money anyway, then do add more to your 401k because it is a great tax benefit. – gaefan Oct 22 at 18:28
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    I doubt this is legal, but it would be cool if it were. From my limited understanding of 401Ks you cannot offer different matching to employees. This prevents the boss from having a 250% match and the employees 50%. – Pete B. Oct 22 at 19:18
  • @PeteB.that was my gut feeling as well, but check out the comments to my answer. – TTT Oct 22 at 19:25

I believe there is a simple answer to this question, but ultimately only you can decide it. From your point of view, assume you are in this position:

I can individually contribute up to $57K into a traditional (pretax) 401k. How much should I contribute?

Once you have your number, you have your answer.

Now, the actual scenario you described is slightly different than that, because if your salary is reduced, you (and your employer) won't pay FICA taxes on that amount, which benefits both of you a little bit more. I suspect this is the reason it's being offered in the first place and in theory you would want to convert as much as possible from salary into employer contribution (up to your target number).

A secondary part of your question is how you would arrive at choosing your number. In general, it can't hurt to have too much saved for retirement, so if you err on the high side it's OK. (See this question and answer for some perspective.) However, you obviously don't want to make your life harder until you get to retirement so there's a balancing act which becomes extremely subjective as to the correct approach. I might try to pick an approximate number you would like to have for retirement, and put the corresponding amount into your 401k right now based on hitting that number. Let's say it's $20K per year. Start there. Then start working on your near term savings and emergency fund goals and fill that up. Then once you've met those goals revisit increasing your 401k contributions to as high as you can, since the payroll tax savings combined with the deferred income tax should be enough to prefer that over any post tax long term investment. I assume you can adjust the amount every year based on your current situation, and if so, perhaps you should.

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    I was surprised about this policy when I joined the company as well - I asked the founder if they were sure it was legal and was assured that it was OKed by lawyers. The policy is documented in writing in the employee handbook, and available to all employees (all of which I'd imagine are well compensated as it is a small tech company). – ChicSheikh Oct 22 at 19:12
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    I believe less than 100 employees, and this is offered to all of them. – ChicSheikh Oct 22 at 19:14
  • @ChicSheikh great information. I updated my answer based on this. – TTT Oct 22 at 19:15

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