By: Joey Casolaro, CFP®
The conventional wisdom in personal finance often suggests maximizing your 401(k) contributions each year. While this advice can be sound for many people, financial planning isn't one-size-fits-all. Just like you wouldn't follow your neighbor's exact grocery list or copy their summer vacation plans (unless it was an epic trip), your retirement strategy needs to be tailored to your specific situation.
For 2025, the maximum 401(k) contribution limit is $23,500, with catch-up provisions allowing those 50 and older to contribute up to $31,000 and those aged 60-63 eligible for up to $34,750. However, there are several reasons why maxing out these contributions might not be the optimal strategy.
Short-Term Financial Goals May Take Priority
Consider Sarah, a software developer earning $200,000 annually. While she could contribute the maximum $23,500 to her 401(k), she's instead directing a significant portion of her savings to a taxable brokerage account. Why? Sarah's primary goal is to purchase her first home within the next five years. By investing in a brokerage account, she maintains access to these funds without the early withdrawal penalties that would come with a 401(k) distribution. She's still investing for retirement through a Roth IRA, but her home down payment takes precedence in her current financial strategy.
This approach illustrates an important principle in financial planning: your strategy can and should evolve with your life circumstances. Once Sarah purchases her home, she plans to redirect those down payment savings back into retirement accounts, potentially maxing out her 401(k) at that time.
Think of it like studying for multiple exams. You have an A in most of your classes, but there’s one class where you have a C, and the final exam is coming up. While you still review your stronger subjects to maintain your grades, you dedicate extra time to the class where you’re struggling because it needs the most attention right now.
Sarah’s financial strategy works the same way. She’s still saving money for retirement (keeping up with her strong subjects), but focusing extra effort on saving for a home (improving her C-grade class) because it’s her most immediate need. Once she reaches that goal, she can shift her focus and put more effort into maximizing her retirement savings, ensuring long-term financial success.
Understanding Your Company's Retirement Benefits
Many employees don't realize that their company's retirement contributions can come in different forms. The most common is a “matching” program, where your employer matches a portion of your contributions. For example, a company might offer a 100% match on the first 3% you contribute and 50% on the next 2%. With a $200,000 salary, if you contribute 5% ($10,000), your employer would add $8,000 ($6,000 for the first 3% plus $2,000 for the next 2%), bringing your total retirement savings to $18,000. This type of matching arrangement essentially provides an immediate 80% return on your contributions up to that 5% threshold.
However, some employers may take a different approach, such as a "safe harbor" provision. Under this arrangement, the company contributes to employee retirement accounts regardless of whether the employees contribute. For instance, a company might automatically contribute 3% of an employee's salary to their 401(k), even if the employee contributes nothing. Some companies even use a more generous safe harbor formula, contributing up to 4% of salary. With an $85,000 salary, you'd receive $2,550-$3,400 in employer contributions whether you save any of your own money or not. In this scenario, maxing out your 401(k) might be less crucial since you're already receiving the employer benefit without contributing yourself.
Cash Flow
Using Sarah as our example, let's assume she lives in an area with a high cost of living. After accounting for essential expenses like rent, utilities, insurance, and student loan payments, she might find that maximizing 401(k) contributions would leave her with insufficient monthly cash flow. However, you could still make significant progress toward retirement by contributing your income through a combination of vehicles: maxing out a Roth IRA, making a moderate 401(k) contribution, and investing in a taxable brokerage account. This balanced approach provides both retirement savings and financial flexibility.
The decision about how much to contribute to your 401(k) should be part of a comprehensive financial strategy considering your current needs, future goals, and tax situation. Consider working with a financial advisor to develop a personalized plan that balances retirement savings with other financial priorities. Remember that you can adjust your strategy over time as your circumstances change – what works best at age 25 might not be optimal at age 35 or 45.
Joey Casolaro is a CERTIFIED FINANCIAL PLANNER® at HIGHLAND Financial Advisors, a Fee-Only fiduciary wealth advisory firm that offers comprehensive financial planning, retirement planning, and investment management. Joey graduated from the University of South Florida with a bachelor’s degree in personal finance and successfully passed the CFP national exam in 2021. Joey enjoys working out, spending time outdoors, and hanging out with family and friends in his free time.