does my 401k still make sense

Does it still make sense to contribute to my 401k? This is a common question we’re hearing even more frequently this year.

Benefits to contributing to your 401k 

Contributing to your employer’s 401k plan has some benefits. The best-known “benefit” is that contributions to a traditional 401k are pre-tax. In other words, the money you contribute this year will not be subject to income tax this year. Another benefit is that your employer may match some or all of your contribution—essentially free money. For high earners, one of the best features of some plans is the ability to contribute to a Roth account, which is not limited by your income level.

And some drawbacks 401k contribution limits

There are also some drawbacks to contributing to your employer’s 401k plan. First, in exchange for the tax deferral on your contribution, you generally can’t withdraw the funds from the plan before age 59 ½ without a penalty. Even after age 59 ½, some plans don’t let you withdraw funds until you leave the employer. Also, the number of investment options in the plan may be relatively small and not what you would otherwise choose as investment funds. And finally, you can’t easily use the money in your 401k plan for other expenses that may come up before you retire. 

Back in 1981, when 401k plans were initially devised, income tax rates were much higher. The theory was that workers could contribute pre-tax money to their retirement fund during their working years and then pay the tax on the funds as they withdrew the contributions and any investment earnings during retirement. The distributions would be taxed at the rate for ordinary income. There would be no tax drag on the retirement investment account from when the funds were contributed until they were withdrawn. Another key part of the theory was that the household income would be less during retirement, and therefore, the retiree would be in a lower tax bracket. 

However, things have changed since 1981. Notably, personal income tax rates are lower now, so the tax savings on contributions are not as significant. Today, many people do not see the reduction in income at retirement that was accepted as a general rule in the 1980s, so they may not be in a lower tax bracket. And tax brackets may change simply due to legislation rather than income levels. 

Does this mean I shouldn’t contribute to my 401k? 

Not necessarily. First, free money is free money. If your employer offers a match, we suggest you consider contributing at least enough to get the maximum match from your employer. 

After the free money, the question becomes more complicated. Consider these factors. 

Factors to consider 

If your employer’s retirement plan offers a Roth component, you may want to consider making Roth contributions. With Roth contributions, you don’t get a deduction for your contribution in the current year. But, the contribution and any growth can be withdrawn tax-free in retirement*. If you believe you may be in a higher tax bracket during retirement, a Roth contribution may be the way to go. Remember, you will have Required Minimum Distributions (RMDs) from your traditional IRAs and your 401ks. You would be required to take these distributions starting in the year that you turn 73 if you turned 72 in 2023 or later (72 if you turned 72 between 2020 and 2022, and 70 ½ if you turned 70 ½ before January 2020) whether you need the funds or not. In some cases, this can push you into a higher tax bracket. 

Also, at retirement or sometime after you separate from your employer, you could roll over the Roth component of a 401k into a Roth IRA. Required Minimum Distributions no longer apply to Roth 401k or  Roth IRA accounts. You could leave the funds in your Roth IRA to continue to take advantage of tax-free potential investment returns. And you can withdraw those funds when you want to rather than being forced to withdraw a portion annually. 

Yes, you can accomplish the same thing by contributing annually to a Roth IRA. However, the annual limit on contributions to an IRA is only $7,000, or $8,000 if you’re 50 or older. The limit on Roth 401k contributions is part of the limit on total 401k contributions. You could choose to contribute up to the $23,000 maximum ($30,500 if you’re 50 or older) to the Roth component of your 401k plan. And the ability to contribute directly to a Roth IRA is limited by income – it starts phasing out at $146,000 in MAGI for single filers and is completely phased out at $161,000. The phase-out range for Married Filing Jointly households is $230,000 to $240,000. The ability to contribute to a Roth 401k is not phased out based on income**. 

Access to investments 

In some cases, you may gain access to investments in your 401k that you would not have as an individual investor. Sometimes, this may be a share class of a mutual fund, and in other cases, it may be access to funds from a particular investment manager. There are times when you can access suitable investments appropriate for your needs at a lower cost in your 401k account than you could elsewhere. This really depends on your employer and how much they subsidize expenses related to the plan. 

Income (tax) management 

There are times when you may want to contribute to your 401k plan simply to lower your tax bill for the current year. For instance, if you’re married and filing jointly and you expect your adjusted gross income to be $165,000, you will be $5,000 into the phase-out range for the American Opportunity Tax Credit. This is a valuable credit for those who have paid qualified college expenses. By contributing at least $5,000 to your traditional 401k plan, you have saved for your retirement and may have qualified for the full tax credit. Of course, this requires some planning, and you’ll need room in your cash flow to accommodate the contribution. 

As usual, the answer is “It depends.” 

Whether it makes sense to contribute the maximum to your 401k or contribute at all depends on your financial situation and your goals. If you have access to a Roth 401k, it definitely makes sense to evaluate how having Roth funds gives you more options in retirement. And, if your employer wants to help you save for retirement by matching your contributions, you should see how you can take advantage of that free money. You should also be sure you understand the features and provisions of your 401k plan, so you know when you can make elections, how often you can change them, and what the investments and fees associated with the plan are. 

And, you’ll need to re-evaluate your decisions any time the playing field or the goal changes. If we have another legislative package that impacts how 401k plans function or otherwise influences your tax situation, you’ll want to see if your current strategy still makes sense. If you change employers or the provisions of your current plan change, you will also want to determine if you need to make changes to your 401k plan contributions. And, if you change your timing or your definition of retirement, you’ll want to revisit how your retirement funds fit into your plans. As a financial planning client with Infinity Financial Strategies, we review and evaluate your 401k options and the impact of these factors to determine what makes sense for you. 

* Subject to qualifications such as age. 

** However, your employer may limit the amount you can contribute to your 401k plan if you are a Highly Compensated Employee. 


This article is intended to be educational and thought-provoking rather than financial advice. When we work together in a financial planning engagement, we discuss your unique personal situation and your unique goals. We examine these factors and many others during our financial planning process to determine appropriate financial strategies for YOU.

Recommended Posts