Take It to the Limit?

Kyle McIntosh

LIKE SOME OF YOU reading this, I get a thrill from seeing my 401(k) contributions start at zero in January and tick up to the annual limit. I’ve been fortunate to maximize my contributions for most of my 24 working years. Last year, my contributions topped out at the 2021 limit of $19,500. In 2022, I’m aiming to make the maximum contribution of $20,500. For those age 50 and older, you can contribute up to $27,000 in 2022.

Up to now, I’ve considered it a no-brainer to contribute the 401(k) max. While I’m not making any changes this year, I am starting to think differently as I inch closer to retirement. If you’re in a similar situation, here are three factors you may want to consider when deciding how much to contribute.

First, if you’re in a low-tax bracket or live in a low-tax state, the tax benefit of contributing pretax dollars to a 401(k) account could be minimal. If you think your tax rate will be higher in retirement, you could be better off investing through a standard brokerage account and paying tax on your earnings now. You could also opt for a Roth 401(k) if your employer offers that option. Factors that might drive your future tax rate higher include a retirement account that’ll generate significant income or plans to move to a higher-tax state.

A second factor to consider is how you’ll invest the funds. If you will be conservative when investing 401(k) contributions, the benefit of deferring tax on investment earnings will be minimal. It may be worth paying the small annual tax bill and having immediate access to your savings.

Finally, you should consider how long the funds will be in the 401(k) account. If you have many years—or even decades—before you’ll withdraw the funds, contributing to the 401(k) will be beneficial from a tax standpoint. But if the funds will sit in the 401(k) account for only a few years, the tax savings on your investment earnings will likely be modest.

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