Here's Why You May Want to Stop Funding Your IRA or 401(k) Sooner Than Expected

If you're into retirement planning, you may know that Social Security probably won't be able to cover your expenses in full once you stop working. Those benefits might only replace about 40% of your preretirement income, and you'll probably need a lot more money than that to live comfortably. That's where your savings come in.

You may be inclined to try to max out your IRA or 401(k) each year. And it's easy to see why.

Image source: Getty Images.

Traditional IRAs and 401(k)s come with pretty sweet tax breaks. Your contributions go in on a pretax basis, shielding some income from the IRS. And gains in an IRA or 401(k) are also tax-deferred, so you're not paying the IRS until you start taking distributions.

But there may come a point when it pays to stop contributions to a traditional retirement account and instead put your money elsewhere -- or stop saving for retirement completely.

Too much IRA or 401(k) savings could become an issue

You might assume that there's no such thing as having too much savings. In reality, too large an IRA or 401(k) balance could become a problem.

Once you turn 73 or 75, depending on your year of birth, you'll have to start taking required minimum distributions, or RMDs, from traditional retirement accounts. Those RMDs could not only drive up your tax bill in retirement but also have other consequences. They could help trigger taxes on your Social Security benefits and leave you with Medicare surcharges.

Blowing off your RMDs isn't a good option, either. Doing so means risking a 25% penalty on whatever RMD you don't take. But if you keep funding an IRA or 401(k), your RMDs could be huge.

Not diversifying could make early retirement impossible

Another reason not to save too much in an IRA or 401(k)? These accounts force you to wait until age 59 1/2 to remove funds or otherwise risk an early withdrawal penalty worth 10% of your distributions. But if you're someone who consistently maxes out an IRA or 401(k), you may end up in a position to retire sooner.

Let's say you put $1,500 a month into a 401(k) plan, which isn't even maxing out, starting at age 22 and do so for 32 years. By age 54, you could be sitting on over $2.4 million if your portfolio gives you an 8% yearly return, which is a bit below the stock market's average.

You may decide you're happy with $2.4 million and change and that you want to retire at 54. But if all of that money is in a traditional 401(k), you'll generally be looking at early withdrawal penalties to get it out for a good number of years.

That's why, at some point, it could pay to split your savings between a traditional retirement account and a taxable brokerage account. That could give you more flexibility both in the event of an early retirement and a more "on time" retirement, since you won't have to worry about RMDs.

You might already have enough savings

One final thing to consider before you keep funding an IRA or 401(k) is that you may have already saved enough. And if that's the case, there may only be an incremental benefit in continuing to save when the extra money could make the tail end of your career easier and more enjoyable.

Let's say you want to retire at 62, but by age 57, you have $3 million. That may be more than enough to cover your needs once you stop working. Even if you don't add another dime, at a conservative 5% return, your $3 million could become $3.8 million five years later.

Instead of pushing yourself to keep contributing to an IRA or 401(k), you could consider keeping the money you would've put in for yourself and using it to outsource home maintenance, get a more comfortable car, or take a few nicer vacations rather than wait until retirement to travel.

The larger your retirement nest egg is, the more peace of mind you might have wrapping up your career. But that doesn't mean it always pays to keep funding an IRA or 401(k). And you may reach a point when it pays to stop, even if you're nowhere close to leaving the workforce.

The Motley Fool has a disclosure policy.