If you talk to 100 financial advisors, chances are 99 of them will recommend that you max out your retirement savings if you can. It is hard to argue the tax benefits and long-term potential of a 401(k) plan or quibble with the advantages of a traditional or Roth IRA.
In most cases, the advice to contribute the maximum amount to your 401(k) plan at work and plow more money into your IRA makes perfect sense. Even so, there are times when maxing out may not make sense.
Below, International Financial Executive with clients ranging from Dubai to Fort Myers, Mike Hainsworth, explains three scenarios where maxing out your retirement plan savings could be unwise or counterproductive.
1. You Have High-Interest Debt
If you have outstanding credit card bills or other high-interest debt, your number one goal should be getting rid of it. If that means putting your retirement savings on hold for a year or two, so be it. While it may be nice to max out your IRA or contribute more to your 401(k) plan, retiring the high-interest debt will almost always take precedence.
Look at it this way: paying off a credit card account charging 18 percent interest is like getting a risk-free 18 percent return on your money. That is performance no retirement plan is likely to match, so focus on paying off your debts first. Once the debts are paid off, you can redirect the freed up cash to your retirement savings plans.
2. You Do Not Have an Emergency Fund
Saving for retirement is a smart thing to do, but it is by definition a long-term endeavor. If you do not have an emergency fund in place, you could be forced to take out a loan on your 401(k) or liquidate your IRA before its time, and that could be a very costly move.
If you take money from your 401(k) or IRA before age 59-1/2, you will have to pay a tax penalty, as well as income tax on the amount you withdraw. Having an emergency fund in place can protect you from this expensive scenario, and building up those contingency savings should be a top priority.
It may make sense to put your retirement plan contributions on hold for a couple of months while you beef up your emergency savings. Once your emergency savings are fully funded, you can put your extra cash to work again.
3. You Are Stuck in a High-Cost Plan
Workplace retirement funds like 401(k) plans can be great ways to save, but not all plans are created equal. Some employers saddle their workers with high-cost mutual funds, and others allow plan administrators to pile on extra fees.
If you are stuck in a high-cost 401(k) plan, maxing out your contributions could be counterproductive. The best course of action is to talk to your employer about lower cost options. In the meantime, you can always max out your IRA and use any excess cash to boost your after-tax savings and investment accounts.
In the vast majority of cases, maxing out your 401(k) and IRA plans make perfect sense. The contribution limits for these plans are quite high, and every dollar you contribute can lower your tax bill and provide long-term, tax-deferred growth. At the same time, there are times when maxing out your retirement plans makes less sense, including the three scenarios outlined above. If you recognize any of these scenarios, you may want to rethink your contribution plans and put your money to work where it will do the most good.
About Mike Hainsworth: Mike Hainsworth of Fort Myers is a seasoned financial consultant with over two decades of experience in the financial services industry. He has helped clients from Florida to Dubai preserve their wealth by minimizing taxes and avoiding losses to secure financial stability for them and their heirs.