Why maxing out 401k is not as great an idea as it sounds

Why maxing out 401k is not as great an idea as it sounds

Question 401k like L would from Death Note

In 2013, the maximum contribution is up to $17,500 while it’s an additional $5,500 for those 50 years or older. Everywhere you go on the interent, you can read articles recommending to contribute maximum to your 401k. It frustrates me to hell that people easily make such recommendation, so I’ll jump straight into my stance…

By all means, anyone should contribute enough to get all of the company’s matchings if the company does that.

Beyond that, I argue that contributing maximum to 401k plan may not be as good an idea as we think!

Below are my reasons:

Here I show the result of someone contributing $5000 yearly and growing it over 30 years in a 401k vs. taxable account. I use 7.5% growth rate for 401k to account for some fees. To simplify, I took the tax out using the “Tax Rate in Future” at the end, and it implies future income tax for 401k and future capital gain tax for taxable account. So for 401k, I subtrated out 25% income tax while for taxable account, I subtracted 15% capital gain tax from just the gains to get the totals. This result tells me that the advantage of a 401k account is minimal and cannot outweigh the disadvantages mentioned. I provide a few more math results by changing the variables at the end of the post.

The final take away is, maxing out 401k is really a personal preference where it is hard to say if it’s truly the best option for planning retirement. Assuming you can implement the same investment strategy, the advantage is minimal while there are disadvantages and more unknowns in the futures due to the 401k money being tax-deferred.

Personally, the advangages and disadvantages are largely a wash so I’d rather have flexibility controlling my money in taxable accounts and not have it locked up.

At any rate, what I really am saying is that each of us needs to understand thoroughly before jumping on the max-out-your-401k wagon.

We didn’t talk about Roth IRA here but it is likely a better option to put money into Roth IRA first vs. maxing out 401k. Also, having a taxable brokerage for investment should also be considered and done in junction with 401k, Roth IRA, etc.

All of us need to have saving/investment vehicle outside of 401k because let’s recall, 401k was created as a supplemental vehicle to help us save for our retirement — not the only thing we use.

More Math examples with varying parameters and results:

Rate of return for 401k is 7% to simulate more fees.

Rate of return for 401k is 7% to simulate more fees and future income tax is increased to 30%.

Rate of return for 401k is 7% to simulate more fees. To simulate tax increase across the board, future income tax is increased to 35% and future capital gain tax is increased to 20%.

Rate of return for 401k is 8% assuming a good plan with minimal fees.

Rate of return for 401k is 8% assuming a good plan with minimal fees and future income tax is increased to 30%.

Rate of return for 401k is 8% assuming a good plan with minimal fees. To simulate tax increase across the board, future income tax is increased to 35% and future capital gain tax is increased to 20%.
Rate of return for 401k is 7% to simulate more fees and future income tax is increased to 30%.

Originally posted 2013-01-16 01:13:55. Republished by Blog Post Promoter