The 6th Financial Commandment for Millennials: When it's (Not) Smart to Max Out Your Retirement Plan

Whether you’re enrolled in an employer retirement plan like a 401k, are self-employed and can utilize a SEP or Solo 401k, or are forced to brave it alone and contribute to a personal IRA – and you’ve completed the previous Financial Commandments for Millennials it's time to start making the maximum contributions to these plans. 

First things first, regardless of how your 401k or other employer plan’s investments and fees are structured, investors should always contribute enough to their employer retirement plans to receive the full employer matching…aka the free money.

After that, don’t max out your contributions blindly. There are a number of factors that should be considered when determining where your savings should be invested, and an employer retirement plan should be analyzed just as thoroughly as any other investment vehicle.

For example, a low earner with access to a poorly constructed and expensive 401k plan may find it more advantageous to only contribute enough to receive the full employer matching (free money), while making the remainder of their contributions to a Traditional or Roth IRA that offers full diversification with lower fees; at least until they reach maximum IRA contributions.

If the same investor is a high earner, eating those high expenses might be worth it. Inherently, these investors have more excess income to be deferred in the first place.  If they’re in the 32% tax bracket currently, they may want to defer income until they retire in a few years and their tax bracket drops to 22%. In this scenario, the tax savings may outweigh the high costs of the 401k plan.

The bottom line is that everyone’s circumstances are different and investors need to be aware that just because they have access to a 401k plan doesn’t mean it’s always the best investment option.

Ideally, you’d want to see total expenses equal to or less than 1%; anything near or above 1.5% should give you cause for concern. You can also reach out to a fee-only financial advisor who can help you determine your plan’s fees and the best investment strategy for your personal situation.

You could also ask for a copy of your plan’s 408(b)(2) and 405(a)5 fee disclosures and fund expense breakdown to find out.
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Once you determine the best vehicle(s) to make your contributions, how should you invest it? You can refer to last month’s article Asset Allocation and Risk Tolerance or you can access Oak Street Advisors’ 401k Like a Boss employer plan investment strategy workbook as a starting point.