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Should I Max Out My 401(K) Early in the Year?

When it comes to investing, time is your best friend. With enough time, you can weather nearly any financial storm, and the power of compound interest will only become stronger and stronger. Why wait until tomorrow to invest when you can invest today? And if you have a 401(K) at your work, you may find it tempting to commit a more significant chunk of your salary to maximize your contributions as soon as possible. 

Maximizing early may indeed have a place in your investment strategy, but there are other considerations you should factor in before making that determination.

Do You Have High-Interest Debt?

Investing doesn’t make much sense as long as you have high-interest debts dragging down your investment momentum. Imagine your average investment returns are at 10%, and your credit card interest rate is 18%. What’s growing faster? Your debt, of course. The quicker you pay off that debt, the faster you can get the power of compound interest on your side – not the bank’s. 

To illustrate the point, imagine you have $10,000 in your 401(K), earning a 10% annual return. Simultaneously, you also have a $10,000 credit card debt with an 18% interest rate. You’re currently allocating $400 monthly to both your 401(K) contribution and your credit card debt repayment.

 

Paying off your credit card debt would take 32 months, costing a total of $12,627.20, with $2,627.20 being just the interest. During these 32 months, if you continue to invest $400 monthly into your 401(K), alongside the initial $10,000, your investment would grow to approximately $27,525.

Now, let’s consider a different approach. If you prioritize your credit card debt by doubling your monthly payment to $800, you would clear the debt in just 14 months and pay only $1,156.95 in interest. Once you extinguish your debt, you can then redirect the full $800 monthly toward your 401(K). After a total of 46 months (14 months for debt repayment plus the subsequent 32 months), your 401(K) balance would reach about $42,157.00.

Comparatively, if you continued with the initial approach of $400 towards each debt repayment and 401(K) investment, after the same 46 months, your 401(K) would only grow to around $36,709. 

As we can see, you’re coming out on top by paying off your high-interest debt as quickly as possible before going all in on your investments. Plus, you’ll have much less stress without that burden weighing down on your shoulders!

Do you have an emergency fund?

Once you’ve contributed to your 401(K), you need an excellent reason to pull from it (if you’re not in retirement already, that is). Firstly, your 401(K) savings are tied up in equities and bonds. You’ll first have to sell some of your assets, and then you’ll have to withdraw the cash. ‘

This can take a while, and if it’s an emergency, time is of the essence. Additionally, you’re facing income taxes on your withdrawals and potentially early withdrawal penalties – further exacerbating your financial woes. To top it all off, you’re weakening your savings’ ability to generate compound gains. 

So, before considering bumping up your contributions, make sure you have three to six months of savings you can access quickly in case of an emergency.

Is your 401(K) any good?

Many 401(K) plans have limited investment options and higher-than-average operating expenses. If that sounds like your 401(K), perhaps your money could be better put to work in another kind of tax-advantaged savings account, such as an IRA. IRAs are self-directed, meaning you choose the investments and, therefore, your expense ratios. 

However, you can only contribute $7,000 to your IRA ($8,000 for those 50 and up) in 2024, while 401(K) limits are at $23,000 ($30,500 for those 50+). So, if your 401(K) expenses are high, perhaps you should max out your IRA first before focusing on your 401(K).

Do you have a company match?

A company match typically only matches up to a certain percentage of your salary and contribution. For instance, a standard structure might be a 50% match on your contributions, up to 6% of your salary. This means if you contribute 6% of your salary, your employer will add an additional 3% (50% of your contribution). Your 401(K) plan will likely differ, so be sure to talk with your plan provider for guidance. 

However, if you contribute more than this threshold, you won’t receive any additional match. For example, contributing 10% of your salary would still only yield a 3% match. If you maximize your contributions early, you’ll miss out on any further matching contributions. 

The company match is essentially free money and one of those rare times when your investment is essentially guaranteed. Due to that fact, contributing the bare minimum to get your full company match often trumps other financial variables, such as paying off debt or establishing an emergency fund. However, financial priorities can differ based on personal circumstances, so it’s advisable to consult a financial advisor for tailored advice.

Finally - should you max out your 401(K) early in the year?

If you aren’t burdened by high-interest debt, lack other financial priorities, have an emergency fund, don’t receive a company match, and your 401(K) has a wide variety of great, low-cost investment options, then sure, maximize early (after consulting with a financial professional to help you make that determination)! In fact, you’ll be giving your savings even more time to generate compound gains, and you can contribute more to a 401(K) than an IRA.

In Conclusion

The 401(K) is a fantastic investment tool and, by now, the backbone of the American retirement system. However, it’s just one piece of the puzzle, and any contributions you make now will significantly impact your tax situation later. By contributing to a tax-deferred 401(K), you’re essentially kicking the tax can down the road, and in retirement, that tax can might turn into a tax bomb. However, if you make Roth contributions, you won’t be burdened with Required Minimum Distributions or income taxes on your retirement withdrawals. 

It’s possible to combine all the pieces to create an investment portfolio with minimal tax drag, allowing your investments to grow faster and more efficiently. Sitting down with a tax-focused financial advisor is the first step in creating your tax-efficient retirement plan – just click the button below to get started!

For informational and educational purposes only and should not be construed as specific investment, accounting, legal or tax advice. Certain information is based on third-party data and may become outdated or otherwise superseded without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. The scenario mentioned in this presentation is not an actual client experience. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this presentation.

About the Authors

  • Douglas Walters

    Doug is the Managing Partner of Walters Strategic Partners, LLC, a licensed Registered Investment Advisory firm. Doug is a licensed Certified Public Accountant (CPA) in the state of Florida and holds a Series 65 Investment Advisor Representative securities license. He is also a member of the AICPA. With over 28 years of experience as a CPA, he believes investment decisions should be based on decades of peer-reviewed research rather than relying on the latest “hot tip” from media outlets. This empirical evidence puts the science of investing to work for his clients.

  • Jose Joia

    Jose M. Joia is a Wealth Advisor at Walters Strategic Advisors, LLC. As a member of the team, Jose’s responsibilities involve comprehensive wealth management, planning and customer service. He has over 6 years of industry experience specializing in planning and solving unique issues his clients encounter. Jose has experience serving individual clients, business owners and non-profit organizations.

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