Maxing Out Your 401(k) Is Not Enough

Okay, it’s a little click-bait-y, but it’s true! For some of you, at least.

In the personal finance business, saving to your 401(k) is practically the first commandment. For younger folk (20+ years away from retirement, say), the advice generally goes: Max out your 401(k) and that’s good for now.

As with most rules of thumb, this is an excellent start. And if you don’t know any better, you could do much worse. But if you’re in the tech industry, making good money, and all you do is max your 401(k), you’re probably saving way too little and, on the flip side, cultivating a habit of spending too much.

How Much Should You Save for Retirement?

The rule of thumb about saving for retirement is that you should save at least 15%, and even better 20%, of your income towards retirement. You Extreme Early Retirement acolytes will want to save far more. Be sure to include not just your salary, but your bonus and any vesting RSUs and other sources of income.

When you’re 15+ years out from retirement, it really is folly to get more specific than this. Too much can change outside of your control (your salary, your expenses, the markets, the economy, your job, your family situation).

The Flip Side of Too Little Savings = Too Much Spending

Keep in mind that every dollar saved is not just a dollar you can use in your retirement, it represents one dollar you didn’t spend. And the amount of money you need in retirement is dictated mostly by how much you spend. If you train yourself over your working life to spend less, then you’ll likely spend less during retirement. Which means that you’ll need less money saved up for retirement.

So, every dollar you save instead of spend helps you reach your retirement savings goal in two ways: it gets you closer to “the number” and it also lowers “the number.”

Which is why I think it’s important to include not just your salary, but all sources of income in this “15% rule.” Those vesting RSUs might not be an every year thing, but if you don’t save it, that means you spend it, setting a precedent for spending for the rest of your life.

Why a 401(k) Might Not Be Enough

You can save a maximum of $18,000/year to your 401(k). That $18,000 is the same whether you live in Newport News, VA (my hometown) or San Francisco, CA.  It’s worth about half as much in San Francisco. At the same time, salaries are much higher in San Francisco. Let’s say, twice as much. It follows that you should save twice as much for retirement. But the IRS doesn’t make allowances for cost of living, so they don’t allow people in San Francisco to save $36,000 to their 401(k).

Let’s walk through it:

$18,000 is 15% of $120,000. That’s the baseline savings recommendation for retirement.

• If you earn $120,000 and you max out your 401(k) with 18%, you are doing the bare minimum of what is recommended to save for retirement.
• Let’s say you make $150,000. $18,000 is 12% of that.
• What if you make $200,000? $18,000 is 9% of that.

In Newport News, VA, very few people make that kind of money, so their $18,000 contribution is fine. In the Bay Area (and Seattle and New York City, etc.), lots of people make that kind of money, and more. $18,000 is very much not fine for them.

If You Don’t Have a 401(k)

401(k)s are wonderful ways to save: your savings are automatically taken from your paycheck and the contribution limits are relatively high. But not all companies offer 401(k)s. If you work for a startup, you likely won’t have a 401(k) available to you. Your employer might provide a SIMPLE IRA, or more likely, you’re left to your own devices, and you need to use a plain old IRA that you set up and fund yourself.

The main difference I want to point out here is that while you can contribute a max of $18,000/year to a 401(k), the contribution limits on other retirement plans are much lower. $12,500 for a SIMPLE IRA and $5500 for a traditional or Roth IRA.

So, the problems I’m talking about with regards to a 401(k) are even worse for these types of savings accounts. And you’ll need to be even more vigilant about saving for retirement in other ways.

How Else Can You Save, Then?

401(k)s are easy to save to. Contributions are deducted automatically from your paychecks. You might even be automatically enrolled, with a default contribution percentage and investment choice, upon joining a company. Pretty much any other savings vehicle is going to be more difficult.

But not that much more difficult.

A Taxable Account

There are several ways to save in addition to your 401(k), if you need or want to. By far the simplest and most versatile is to open up a regular brokerage account, aka, a taxable investment account, at a custodian (by which I mean a Vanguard or e-Trade or Schwab).

Easiest thing to do is to set up an automatic paycheck deposit to go directly to that account so it never touches your greedy little hands.

Your investments are unrestricted, which means you can more easily get access to broadly diversified, inexpensive funds (if you follow my lead). Alas, sometimes 401(k)s have crappy investment options, and you’re kind of stuck with them.

And lastly, name this account “For Retirement” and separate it from your other taxable investments, because I don’t want you digging in to this account for anything but retirement, if possible. If you don’t make it explicitly “For Retirement,” the temptation will be much bigger to spend it on a house or college or your life-long travel dream.

Other Options

1. Save to a Roth 401(k) instead of a traditional 401(k). (Applicable, of course, only if your plan offers a Roth option.) Now, why would this increase your savings rate? Because you’re able to effectively save more money to a Roth account.When you put money into a traditional 401(k), 20 to 40%-ish percent of that money actually belongs to the government, in the form of taxes when you withdraw the money in retirement. So, if you save $18,000, you’re really only saving, say, $13,500 (25% less). But if you save to a Roth 401(k), you owe the taxes now, and if you can pay those taxes with other money, and shove the entire $18,000 into the Roth 401(k), all that money with all its earnings are 100% yours come retirement. (With allowances for unknowable changes to tax law.)
2. Make after-tax contributions to your 401(k). This is not the same as saving to the Roth account in your 401(k) plan. What’s pertinent here is that it allows you to save (way) more than $18,000/year. The contributions will, eventually, come out tax-free. The earnings on those contributions, by contrast, will be taxed just like any other money in a 401(k). More details here.

Sometimes It’s OK to Not Max Your 401(k)

Regardless of income or savings rate, sometimes (rarely, but sometimes) there are better uses for your money than contributing to your 401(k). “Heresy!” you say. I persevere.

First you need to contribute enough to get your full match, because hey, that’s free money. Instead of then continuing on to max out your 401(k), you might be better served by:

1. Building up your emergency fund. In the tech industry, I think at least 6 months’ worth of your basis expenses is appropriate.
2. Spending on something that will permanently improve your earning potential. If you’re 20+ years away from retirement, earning more every year (and, let’s be clear, Saving That) can provide much more financial strength than a one-time contribution of, say, $5000 to your 401(k). Can you get a degree or training or go to a conference that would make you more desirable in your career? Go for it.
3. Using a different savings “vehicle.” If your 401(k) sucks, I mean, really sucks, consider saving to an IRA and a taxable investment account instead.

Like any good New Yorker article, this blog post went down several tangential rat holes. But I want you to focus on just this:

1. What did you make last year? That includes salary, bonus, vesting RSUs, exercised stock options, ESPP proceeds, etc.
2. What percentage of that did you save?
3. If it’s not at least 15%, figure out another way to save.

Are you uncertain whether you’re saving enough for retirement and your other goals? Would you like to be more certain? Reach out to me at  or schedule a free consultation.

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