The prevailing wisdom is that workers who have access to 401(k) and 403(b) plans should max them out as soon as possible. It’s easy to see why this makes sense on the face of it. Retirement savings are a crucial issue for many Americans. Under-saving can have real repercussions for the future, especially as life expectancies are increasing while the retirement age stays put at 62 to 65.
However, there are some situations where it’s best not to max out a retirement account, or at least not max it out as quickly as possible. Take, for example, a high earner whose company also offers a retirement savings match as a benefit. These matches are typically calculated as a percentage. A worker who funds their account too quickly can actually lose out on matching contributions due to the way they’re calculated. For example, if someone hits their max ($19,000 for most workers in 2019) in October or November, they could lose hundreds of dollars in matching funds. So it’s important to calibrate retirement contributions carefully.
Another consideration is the amount of debt that a given employee is carrying. Typical 401(k) and 403(b) accounts have a return of about 7%. This is certainly better than a standard savings account. It’s more than the interest percentage on student loans. However, it’s much less than the going interest rates for many credit cards. Saving at 7% while accruing more debt at 16%-21% just doesn’t make sense. Compound interest, in this case, works against the investor. In such a case, it can be beneficial to dial back on savings contributions, in favor of clearing up bad debt first. For employees who have a company match, depositing some money may be prudent. But it’s not a great decision to max the account out.
Finally, every employee should take a close look at the investment options offered by their company’s 401(k) or 403(b). Not all plans are created equal. Some offer ten or more different funds for selection, and even allow the saver to allocate by percentage. Others focus on company stock, or offer broad descriptions like conservative or high-risk. If the 401(k) on offer isn’t great, it’s always fine to open an IRA.