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Please advise me whether I understand this correctly:

The benefits of maxing out the 401k:

  1. Your contributions are tax-deductible, so it lowers your income during tax filling
  2. As your money grows over the years, your dividends on that money are not taxed
  3. Usually there is company matching.

The drawback:

  1. Your money is tied up until you retire

Let's say you're making $100k per year.I would imagine that it would be almost foolish to not max out your 401k?

(I am leaving out the Roth IRA out of this equation for simplicity purposes, and just want to discuss the 401k)

Am I understanding the full picture?

  • 1
    4. The annual contribution limit is higher than an IRA. So you can put away more tax sheltered money each year through a 401K. – JohnFx May 8 '15 at 22:17
  • Are you contrasting the 401k to an IRA or to a taxable account? – BrenBarn May 9 '15 at 2:49
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Specifically on the subject of maxing out your 401k, there are several downsides:

  • The employer match usually only applies to the first 6%. Some employers offer no match at all. You listed the match as a pro, but I think it should be pointed out that you can usually get this benefit without maxing out your plan.

  • The investment options are limited. Usually there is at least one fund available from all the common investment classes, but these may not be your preferred funds if you were able to choose for yourself.

  • Fees can be very high. If you are working for a small to medium size company, the fees for each fund will often be higher than for the same funds in a plan offered by a large company. Fees are usually related to the dollar amount of assets under management.

Each person has a different tax situation, so if you are single and making 6 figures, you might still be in the 25% bracket even after maxing out your 401k, but the same person filing jointly with a spouse that makes less could get down to the 15% bracket with a smaller contribution. I meet my retirement savings goals without maxing out the 401k. As long as the amount is above the employer match amount, my second priority is to funnel as much money as possible in to my IRA (because I get lower fees and better investment options from Vanguard).

  • Where did the magic 6% come from? – littleadv May 9 '15 at 3:25
  • The company matching is usually to 6%. – Kamilski81 May 9 '15 at 13:16
  • @Nathan L - when you say IRA, are you referring to Roth IRA, or Traditional IRA? – Kamilski81 May 9 '15 at 13:20
  • I was referring to traditional, but the same principles apply to those in lower tax brackets that wish to contribute to Roth accounts. – NL - Apologize to Monica May 9 '15 at 18:17
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First a few comments:

  • Your tax deductions might be tax deductible. If your company has a Roth 401K and you contribute to it, those contributions aren't tax deductible.
  • The 40K limit is higher than the IRA limit
  • Until you starting making withdraws the dividends, capital gains, and matching funds are tax deferred.

Other benefits:

  • If you leave your company you can roll the 401K into an IRA of the same flavor, or roll it over into the new employers 401K.
  • Money in a retirement fund doesn't count when determining the family contribution for college.
  • While the money generally is tied up until you reach retirement age you can make a withdraw but you may owe taxes and penalties. You also may take a loan against the balance in the 401k. There are rules that have to be understood. The general advice is to avoid withdrawing funds before retirement age and to avoid the loans, these options do exist.

It may not be possible for everybody to max out the 401K on an income of 100K. It would depend on family size, other income, other expenses, other debts...

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Sounds about right. Also note that you're usually at the mercy of your job for what's available; if all your choices are terrible (high fees and or low interest), that should figure into your calculations.

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