An IRA contribution may be the better bet in some situations.
PrintCommentRecommend (-)
Bookmark and Share
By Christine Benz | 01-31-11 | 06:00 AM | Email Article

"Max out your 401(k)."

Even folks who pay only passing attention to investing matters have probably heard this directive.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.

And for many investors, it's solid advice. Needless to say, pushing yourself to save as much as you can is invariably a worthy goal, and doing so within the confines of a 401(k) allows you to take the advantage of the tax-deferred compounding that vehicle affords. (In the case of Roth 401(k)s, any growth in your investments and in-retirement withdrawals will be tax-free altogether.)

Let's face it, investing in a 401(k) can be effective simply because it's the path of least resistance. Your contributions will flow into the plan before you even get your mitts on the money, and the vast array of investment choices will have already been winnowed down to a preset menu. Even very inert, hands-off (OK, lazy) investors can get a plan up and running in no time, and sticking with the program is even easier.

But contributing the maximum to such a plan isn't always a slam-dunk maneuver. If your plan is lousy or if you have other worthwhile options vying for your money, you may want to contribute enough to the 401(k) to earn any employer-matching funds, then consider other options, such as a Roth IRA.

Here are the key questions to ask before contributing the maximum to a 401(k) plan.

How Good Is the Plan?
Some 401(k) plans tick all of the boxes: topflight, low-cost investment choices, robust employer-matching contributions, a Roth option, a brokerage window, and no additional layers of costs for administration. Alas, other plans fall down on one or more of these options. No brokerage window or Roth option? Not a deal-breaker. But if a plan has poor, costly investment choices and additional layers of fees, that's a good reason to explore other options before maxing out.

This article discusses some of the key features to look for in a 401(k). If your plan doesn't measure up, your best option is to contribute only what you need to take advantage any matching funds, then take any additional hard-earned dollars and put them into an IRA. If you've contributed enough to earn a match, filled up an IRA, and still have money to invest, only then should maxing out the 401(k) be on the table.

Do You Have Better Things to Do With Your Money?
Saving for retirement is important, but it's not always priority number one. Obviously, if you have high-interest-rate debt, paying it off should take precedence over saving. Not only is the return on your money apt to be higher than what you will earn on your investments, that return is guaranteed. If you're nearing retirement, even benign debt like your home mortgage can be a worthy target for your cash, as this article discusses.

Withholding a maximum 401(k) contribution will also make sense if you don't have adequate emergency reserves in place--three to six months' worth of living expenses set aside in a highly liquid account in case you lose your job or encounter some other unforeseen expense. True, you could borrow against your 401(k) if you had to, but you'd have to pay the money back, with interest, within a prescribed period of time. If you lost your job, you wouldn't want to have to deal with those strictures.

Securities mentioned in this article

Ticker

Price($)

Change(%)
Morningstar Rating Morningstar Analyst Report
With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds
Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
Sponsored Links
Buy a Link Now
Sponsor Center
Morningstar - 2011/01/31 - The Error-Proof Portfolio: Maybe You Shouldn't Max Out Your 401(k) - <a href="http://www.morningstar.com/articles/author/30-christine-benz.aspx">Christine Benz</a>
Name |  Ticker |  Star Rating |  Market Cap |  Stock Type |  Sector |  Industry Star Rating |  Investment Style |  Total Assets |  Category |  Top Holdings |  Top Sectors |  Symbol |  Title Star Rating |  Category |  Total Assets |  Top Holdings |  Top Sectors |  Symbol |  Name Topic |  Sector |  Key Indicators |  User Interest |  Market Cap |  Industry Name |  Ticker |  Star Rating |  Market Cap |  Stock Type |  Sector |  Industry Star Rating |  Investment Style |  Total Assets |  Category |  Top Holdings |  Top Sectors |  Symbol / Ticker |  Title Star Rating |  Category |  Total Assets |  Symbol / Ticker |  Name Title |  Date |  Author |  Collection |  Popularity |  Interest Title |  Date |  Company |  Symbol |  Interest |  Popularity Title |  Date |  Company |  Symbol |  Interest |  Popularity Topic |  Sector |  Key Indicators |  User Interest |  Market Cap |  Industry Title |  Date |  Author |  Collection |  Interest |  Popularity

Previous: The Error-Proof Portfolio: For Annuities, Timing Is Key  |  Next: The Error-Proof Portfolio: Viva la Humble All-in-One Fund