Should I request that my employer reduce my salary to fully max out my 401k?

Question

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.

Answer 1

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.