It May Be Time to Stop Contributing to Your 401(k). Here's How to Know.
Key Points
Funding a 401(k) is a great way to build retirement savings.
If you're convinced you're on track for early retirement, you may want to halt contributions.
You could be penalized for tapping a 401(k) early, so it's important to spread your money around.
- The $23,760 Social Security bonus most retirees completely overlook ›
Contributing to a 401(k) is one of the most seamless ways to save for retirement. You tell your employer how much money to withhold from your paychecks, choose your investments, and call it a day.
Plus, with a traditional 401(k) plan, you get to enjoy tax-free contributions and tax-deferred gains. And if you have a workplace match, that's free money to add to your retirement savings.
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But there may come a point when it pays to stop contributing to your 401(k). Here's how to know if that applies to you.
If you're on track for early retirement, you may want to rethink your 401(k)
Many people wish they could retire early, but their finances don't support it. But if you reach a certain point in your career where you've saved enough that early retirement could easily become reality, you may want to rethink your 401(k) contributions.
The reason? With a 401(k), you face a 10% early withdrawal penalty for removing funds from your savings before age 59 and 1/2.
Now, there can be an exception if you separate from your employer the year you turn 55 or older. In that case, you may be eligible for penalty-free withdrawals a few years before 59 and 1/2.
But either way, with a 401(k) plan, you're limited on when your money is yours to access without a penalty. If, come age 45, you realize you're on track to retire at 52, that's a good reason to stop funding your 401(k) and start saving in a taxable account instead. That way, you'll be able to access some of your long-term savings whenever you want the money.
It pays to give up the tax break
As the name implies, with a taxable brokerage account, you won't get any IRS benefits. The funds you contribute are made on an after-tax basis, and investment gains are taxable every year.
But what you get in return is freedom. So, if you're confident you're in a position to retire early, it may be time to stop making contributions to your 401(k) and focus on funding a taxable brokerage account instead.
Now, that said, it generally pays to keep funding a 401(k) up to your maximum employer match each year. So, if your company matches your first $5,000 in contributions, that's a good reason to stick with your 401(k).
But in that case, you'd want to limit yourself to $5,000 a year in your 401(k) and put the rest of your savings into a taxable account. If you don't, you may find that, because of the aforementioned penalty, you're unable to retire early despite having the money to do so.
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