Maxing Out Your 401(k) Is Profitable: Here's Why
Statistically, most Americans are behind on their retirement savings. In fact, 73% of American employees don't have a retirement plan at all. If you're like the majority of Americans, you need to save aggressively.
With millions of Americans behind in their retirement savings, it is important not only to save, but to save more each year, said Greg McBride, Bankrate.com chief financial analyst and a CFA. Even for those saving the maximum, 401(k) contribution limits increased for 2015, affording the opportunity to put more away for retirement.
Here's how the math works. In 2015 you can contribute up to $18,000 to your 401(k) plan. That's $500 more than in 2014. In order to do that, you will have to contribute $1,500 per month. If you're 50 or older, you can contribute up to $24,000 in 2015. That's a monthly contribution of $2,000.
For most Americans, contributing that much is not possible, but it might be a good idea if you're able. Here's why.It Lowers Your Tax Bill
If you contribute the full $18,000, your tax bill could be $4,500 less. If you're 50 or older and making catch-up contributions, you could save as much as $6,000. It's hard to say no to savings like that.There's Probably a Match
Not all financial planners believe that you should max out your 401(k) savings (read I Maxed Out My 401(k)! Now What?), but they do agree that you should contribute up to your employer match (see Does my employer's matching contribution count toward the maximum I can contribute to my 401(k) plan?) . You're probably getting about 50 cents on the dollar for a maximum of 6% of your salary if you fall into the average. That's the equivalent of your employer giving you a check for around $1,800 for a worker making $60,000 per year. And don't forget that over a period of time, that $1,800 will grow. That makes your employer's contribution worth a lot more than $1,800. Don't turn down free money.You Don't Have to Be an Investing Pro
Once you contribute up to your employee match, you have choices to make. Many 401(k)s have mediocre investment options. You're probably forced to choose among a limited number of mutual funds with higher fees and lower performance.
You'll read articles or receive well-meaning advice to evaluate the available funds in your plan or speak to a financial advisor" – good recommendations if you actually know how do it or whom to consult.
No matter how bad the available choices in your 401(k) are, they're all better than doing nothing at all. The same Bankrate study found that 10% of Americans contributed nothing to their retirement accounts this year or last, and only 19% are saving more for retirement than they were last year.
If you barely understand anything having to do with investing and finance, and you aren't going to pay for a financial advisor, maxing out your 401(k) is the best choice. Not because it's necessarily the best way to save, but because it's better than doing nothing at all.
And most 401(k)s have at least a few low-cost index funds (see The Lowdown On Index Funds) as their offerings. If you're young, put a lot of your money into a stock index fund. As you get closer to retirement, shift the majority of it to a bond fund. Some people say to allocate by your age. If you're 30, keep 30% of your retirement funds in a bond fund. If you're 60, make it 60%.
If you want to learn more about allocation, read Is '100 minus your age' outdated?. If you don't want to mess with allocation, consider a target-date fund (read The Pros and Cons of Target-Date Funds).The Bottom Line
If you have the talent, time to learn and are a little adventurous, you could remodel your home for a fraction of the price of having a pro do it for you. But if you're like most, you don't have the time to learn. The same holds true with retirement planning. There are more potentially profitable ways to invest your retirement funds – IRAs and traditional brokerage accounts, among them (see Can I contribute to both a 401(k) and an IRA?)
But for the sake of your future, putting your money to work somewhere is better than nothing. With a minimum amount of knowledge and research, you can learn about index funds. They come with low fees and they're easier to understand than many other mutual fund types. To learn more, see 4 Ways to Maximize Your 401(k).