The 401K Dilemma: Should You Max Out?

Retirement savings can feel overwhelming, especially with the numerous options available. For many, the question boils down to whether or not they should max out their 401(k)/403(b) plan. These are two of the most common retirement accounts in the United States, and knowing how to use them properly can make a world of difference in your financial future. But who should max out these accounts, and who might be better off redirecting their funds elsewhere?

Today, we’ll break down who should consider maxing out their plans and who might want to rethink that strategy. This isn’t about following a one-size-fits-all guide but tailoring your financial plan to your unique situation.

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Understanding 401(k) and 403(b) Accounts

Before jumping into the “shoulds” and “shouldn’ts,” let’s take a quick look at what these plans are and why they matter.

401(k) & 403(b) Basics:
Both 401(k) and 403(b) plans are employer-sponsored retirement savings accounts. A 401(k) is common in private sector jobs, while a 403(b) is typical for public schools, hospitals, and nonprofit organizations. These accounts allow employees to contribute a portion of their income each year, with many employers offering a matching contribution—essentially free money for your retirement.

Importance in the U.S.:
These plans have become the backbone of retirement savings in the U.S. With Social Security’s future uncertain and people living longer than ever, securing retirement through personal savings is increasingly crucial. Yet, statistics show that most Americans are underprepared. Many haven’t saved nearly enough to maintain their lifestyles after they stop working.

Now that we’ve covered the basics, let’s move on to the pressing question: Should you max out your 401(k) or 403(b)?

The “Should” Group: Who Should Max Out Their Plans

There are several types of individuals who should prioritize maxing out their 401(k) or 403(b). Below, we’ll discuss three key groups of people who should seriously consider doing so.

People Behind on Retirement Savings

Are you behind on your retirement savings? If so, this is an obvious reason to prioritize maxing out your 401(k) or 403(b). The unfortunate reality is that most Americans are dangerously underprepared for retirement. If this sounds like you, maxing out now is critical to ensure you have enough money when you need it later.

Physicians, in particular, often fall behind due to the years spent in school and residency. If you’re just entering your career after an extended period in school, it may feel like you’re playing catch-up with your savings—and to some extent, you are. But don’t worry; you’re far from alone in this situation, and making the most out of your 401(k) is an excellent step toward regaining ground.

Belief in Low Tax Rates in Retirement

Next on the list, if you believe future tax rates will be lower when you retire, then maxing out your 401(k) or 403(b) might seem like a good idea. But here’s the thing—this assumption may not be as solid as you’d hope.

While the logic sounds good (put your money away now, pay lower taxes later), there aren’t many indicators that tax rates are going down anytime soon. With government deficits continuing to climb, it’s hard to imagine a scenario where taxes diminish in the near future, regardless of political affiliation.

Still, for the optimists, if you’re confident that you’ll be in a lower tax bracket upon retirement, go ahead and max out that 401(k)! Just be aware that this window is narrow, and tax assumptions often don’t hold true when required minimum distributions (RMDs) kick in. Which leads us to…

Planning for Required Minimum Distributions (RMDs)

Speaking of RMDs, if you’re planning for them, you should be maxing out your 401(k) or 403(b). But what exactly are RMDs? Once you hit age 75 (as of now for Gen X and younger generations), you’ll be required by law to start taking a certain amount out of your pre-tax accounts. These are known as RMDs, and for those with substantial retirement savings, they can lead to significant tax hits.

So, how do you minimize the damage? This is where Roth conversions during the so-called “Roth conversion window” come in. From the time you retire, until your RMDs start, there’s usually a decade of lower-income years where you can move portions of your 401(k) into a Roth account. By maxing out now and converting later, you dodge higher tax brackets in retirement.

The “Shouldn’t” Group: Who Should Not Max Out Their Plans

Now, let’s flip the coin. Maxing out every year may not be the best move for everyone. Here’s a breakdown of who should be cautious.

Always Take Advantage of Employer Match

Before diving into why you might not want to max out your 401(k) or 403(b), there’s this important rule: always take advantage of the employer match if they offer one. This is essentially free money. If your employer offers to match 100% of your contribution up to 3%, you’d be leaving money on the table by not contributing at least 3%. Always match contributions. It’s a no-brainer.

Identifying a Bad 401(k) Plan

Not all 401(k) or 403(b) plans are created equal. A bad plan could eat away at your savings in ways you might not notice.

• Bad Investment Lineup: Sometimes, your options include high-expense funds, meaning you’re paying more in fees than necessary. Look out for funds with high expense ratios, which reduce your overall return.
• High Administrative Fees: Many 401(k) and 403(b) plans also have hidden administrative fees. The average plan fee is around 0.45%, but it can sometimes be much higher. If your plan fees are eating into your returns, consider adjusting your strategy.

Managing High-Interest Debt

If you have significant high-interest debt, like maxed-out credit cards or personal loans with high APR, don’t max out your 401(k). Pay down that debt first. The logic here is simple: your credit card’s 20% interest rate far surpasses any long-term investment return. If you have any sort of high-interest debt, prioritize paying it off before focusing on your retirement contributions.

Also, don’t compound bad financial decisions. If you made a mistake like buying an expensive car you couldn’t afford, fix it. Don’t continue contributing heavily to your 401(k) while drowning in interest.

Importance of Funding Other Accounts

Maxing out your 401(k) sounds great, but not if you haven’t maxed out other tax-advantaged accounts, like a Roth IRA or Health Savings Account (HSA).

• Roth IRA: This account is funded with post-tax dollars, meaning you won’t have to pay taxes when you withdraw in retirement. High-income earners can still contribute through the backdoor Roth strategy.
• HSA: Often overlooked, the HSA is another excellent long-term savings bucket. While many use the HSA for immediate healthcare needs, it doubles as a powerful retirement tool when used to save for future healthcare costs in retirement.

Before maxing out a 401(k), make sure you’re also taking full advantage of these other options.

Belief in Higher Taxes in Retirement

On the flip side of the low-tax believers, some of you may be sure that tax rates are only going up. If that’s your belief, maxing out a 401(k) now doesn’t make sense. Why defer taxes on your contributions now only to pay more in the future? In this situation, you’re better off prioritizing a Roth IRA, HSA, or even taxable investment accounts.

This strategy takes some foresight, and it’s one of those complex tax planning areas that requires careful consideration. The guesswork involved makes it hard to plan with total certainty.

Lack of Liquidity in Retirement Accounts

Finally, when you tie up your money in 401(k) and 403(b) accounts, you sacrifice liquidity. For the most part, once that money is stashed away, you can’t access it until you turn 59½. Trying to pull it out earlier will result in a 10% penalty on top of regular income taxes unless you meet certain exceptions.

That’s why financial flexibility matters. Spread your investments across multiple types of accounts: 401(k), Roth, and even taxable brokerage accounts. This way, you can access funds without penalty if need be while still saving for the future.

Additional Considerations for Physicians

Since we’re focusing on physicians, let’s talk about a few additional challenges tailored to your career path.

Physicians often start their high-earning years later in life compared to other professionals. After years of schooling and residency, you may feel behind on saving. That’s why maxing out early and catching up becomes even more crucial for you. But don’t forget to also balance paying off any student loans with saving for retirement.

If you’re a physician, make sure to also consider the Roth conversion window we mentioned earlier. After you finish your years of high earnings, there may be a perfect period for you to lower your tax exposure by converting some of your pre-tax savings into a Roth—lowering your tax liability when RMDs come into play.

Tax Planning and Its Complexities

Tax planning is one of the trickiest aspects of retirement savings. Even if you have a plan in place, tax laws can change. We can’t predict the future of the tax code with precision, and this is why ongoing tax planning matters.

A one-time tax strategy might not be enough. You need to constantly assess changes in income, future tax brackets, and savings rules. Even if you work with a financial advisor, tax planning is not a “set it and forget it” strategy—adjustments need to be made along the way.

Strategies for Diversified Retirement Savings

At the heart of good retirement planning lies diversification. You’ve likely heard the phrase, “Don’t put all your eggs in one basket.” This principle applies to retirement savings as well.

By spreading your money across various buckets—taxable accounts, Roth IRAs, pre-tax accounts, and HSAs—you give yourself the flexibility to respond to changes in your life, the market, and tax laws. Having multiple savings vehicles can help you balance your tax exposure and give you the liquidity you might need before retirement age.

Summary of Who Should vs. Who Shouldn’t

Here’s a quick recap:

Who Should Max Out Their 401(k)/403(b):

• If you’re behind on retirement savings- Now’s the time to catch up.
• If you believe future tax rates will be lower- Make the most of tax deferral today.
• If you’re planning for RMDs- Max out now and use Roth conversions to reduce future tax burdens.

Who Shouldn’t Max Out Their 401(k)/403(b):

• If you have a bad 401(k) with high fees- Consider other savings options first.
• If you have high-interest debt- Pay off those credit cards before contributing extra to retirement.
• If you haven’t maxed out other accounts- Prioritize your Roth IRA and HSA.
• If you believe tax rates will rise- Look into other investment vehicles beyond the 401(k).
• If you need liquidity- Don’t tie up all your funds in retirement accounts without penalty-free access.

Retirement planning is personal, complex, and ever-changing. Use the strategies we’ve discussed here to ensure you’re on a path that makes sense for you.

 

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Disclosures