Should You Max Out Your 401(k) Early in the Year?

The 401(k) is one of the most popular retirement accounts in the United States.

Many employers offer one as a benefit for their employees, and most people have the option to stash as much as $19,500 in 2020 in the account before hitting their contribution maximum.

Not everyone can max out their 401(k) contributions every year, or even in any year.

If you can max it out, your decision moves from whether to max your contributions to when to max them.

Should you try to frontload your contributions and max out your 401(k) early in the year?

Or:

Should you make consistent contributions and max it out near the end of December?

It’s a good problem to have, and there are pros and cons to both options.

How to Max Out Your 401(k) Early

Frontloading your 401(k) means making one or more large contributions during the start of the year.

For example:

Someone who wants to frontload their account might increase their contributions to more than $6,000 per paycheck for the first three months of the year.

Typically, an employee who gets 26 paychecks a year would need to contribute about $750 each paycheck to max out their 401(k) by the end of the year.

Frontloading your 401(k) has many benefits and drawbacks.

Pros

Get it out of the way

One of the most obvious benefits of frontloading your 401(k) is that you get it done sooner.

That means you have more flexibility in the latter part of the year because more of your paycheck will go into your pocket instead of your retirement account.

Prepping for a new job that doesn't offer a 401(k)

It also means you’ll use more of your contribution limit if you lose access to your 401(k) when switching to an employer that doesn’t offer one.

This is an especially important thing to consider if you’re planning to leave your current employer.

If your employer offers a 401(k) match, frontloading can help you make the most of that match before leaving your job.

You're trying to invest earlier

Frontloading also means that your money will spend more time invested in the market.

Generally, how long your money remains invested is the most reliable indicator of your investment’s performance.

The sooner you can put your money in the market and the longer you keep it there, you might be able to generate higher returns.

Forced savings

Another reason to frontload is that you can use it to train yourself to live on a smaller income.

If you frontload your 401(k), it reduces the amount of money from each paycheck that’s available for spending.

If you get used to living on a smaller amount, you can decrease your monthly budget.

After you’ve maxed your 401(k) and start getting the larger paycheck, you can funnel the additional money into an individual retirement account (IRA), taxable investments, or a savings account.

Cons

Missing out on the full employer match

While securing your employer’s match is a great reason to frontload, not every employer’s 401(k) matching works the same.

The fact is:

Some employers matching programs will not give you the full match if you frontload your 401(k).

They expect employees who max out their 401(k) to do so with equal contributions every paycheck. If your employer works like this, frontloading means you’ll miss out on matching contributions.

Employers who do max out matching, even if you frontload, are said to offer a “true-up” on their matching contributions.

If you want to frontload, reach out to your payroll department or retirement benefits group to ask about how the matching plan interacts with frontloading.

Decreased spending ability (temporarily)

Frontloading also reduces your budget flexibility early in the year.

If you tie up more of your money in retirement accounts, you’ll have less available to handle financial emergencies.

If you decide to frontload, make sure that you have a sizable emergency fund that you can use if you need to cover an unexpected expense.

Why Slow and Steady Might Work for You

If you’re going to max your 401(k), the alternative to frontloading is to make consistent contributions with every paycheck.

For most people, that means contributing $19,500 over the course of the year. If you’re paid every other week, that’s $750 per paycheck.

Making consistent contributions to your 401(k) is the default strategy for most people. It brings its own pros and cons to the table.

Pros

Dollar-cost average

One pro of making equal contributions every paycheck is that consistent contributions let you take advantage of dollar-cost averaging.

Dollar-cost averaging is the process of spreading out investment over a period of time.

For example, instead of investing $12,000 in a mutual fund on January 1st, you decide to put $1,000 into the fund each month for twelve months.

Dollar-cost averaging lets you avoid the pain of a downswing that occurs immediately after a large investment.

It reduces the impact that market volatility has on your returns, smoothing it out instead.

Better overall budgeting

Making equal contributions every paycheck is also simple.

Most HR systems have an easy button to check that lets you max out your contributions for the year.

You also don’t have to worry about your take-home pay growing when you finish maxing your contributions for the year, only to shrink again on January 1st. This makes budgeting much easier to do.

If you’re maxing out your 401(k), there’s a good chance you’re also making contributions to an IRA or investing in a taxable brokerage account.

Consistent contributions to your 401(k) mean that you have more money available from every paycheck to put toward an IRA or taxable account.

Cons

Losing your job

One of the biggest cons of spreading your contributions evenly across your paychecks is that you run the risk of missing out on contributions should you lose your job. 401(k)s are only available through employers.

If you’re laid off or switch jobs to another employer that does not offer a 401(k), you can’t make further contributions. The annual contribution limit does not roll over from year to year.

That means:

If you lose access to your 401(k) halfway through the year, you can permanently lose out on that tax-advantaged investment space.

Less time in the market

Another drawback is that the market tends to rise over time and the amount of time your money spends in the market is a major part of your investment returns.

Generally speaking, the time your money spends in the market is more important than the timing with which you put the money in the market.

Spreading your contributions out over time can have a slightly negative effect on overall returns.

Easier to forget

Another, minor, drawback of consistent, automatic contributions is that you might pay less attention to your portfolio.

If you never think about your 401(k), when you’re going to max it, and how you want to frontload it, it’s easy to forget that you have one at all.

While you don’t want to make frequent changes to your portfolio, sometimes you need to reassess your investment goals and rebalance your portfolio.

Conclusion

Your 401(k) is one of the most powerful investment tools available to you.

It can help you shield thousands of dollars from taxes every year and many employers offer matching contributions if you decide to contribute to the account yourself.

Frontloading your 401(k) means you can max out the account early in the year and offers a variety of benefits.

With that said:

It’s important that you talk to your HR or benefits department to get the full story.

Does your company offer a full match if you frontload, or do you need to make equal contributions every paycheck to get the full match?

Both frontloading and making consistent contributions have pros and cons, so the decision about the strategy to use is a personal one.

Consider the benefits and drawbacks and choose the one that seems right for you.

Remember:

You can always change strategies for next year so it might be worth trying both if you aren’t sure.