There are more and more articles being written that stress how you're fundamentally making a major mistake by not maximizing or at least, dramatically increasing your contributions to your 401k plan. 

Unfortunately, there's little actual thinking behind the articles touting the options of throwing more money at a less than optimal mode of investing. 

First off, prior to the tax changes in 1987 (TEFRA: The Tax Equities and Fiscal Responsibility Act) simply the notion of retirement plans was a lot more palatable. Before the changes, there were 14 tax brackets and it wasn't hard to conceive that you'd most likely be in a lower one when you retired than you were in while you were working. Even a "less than dramatic" reduction in post-retirement income yielded considerable tax savings. 


TEFRA left us with not 14 tax brackets but three.  And the width of those brackets leave many American's in a position where their post-retirement tax bracket will be the same one they'll retire into. 

Deferring money at the 38% bracket pre-TEFRA and getting it back in the 20% tax bracket looked like a good deal back then, but I'm not so sure it looks as good when you're in the 28% bracket before and after retirement. And let's not forget, that 100% of what you take out of your 401k after retirement is taxable as ordinary income, every single penny of it!

Now, were you to have limited your 401k contribution to the maximum you could put in and get your full employer's match and then figured out something different to do with the rest, that might at the end of the day, be the optimal strategy. 

If your employer matches 50% of the first 6% you put away, the clearly 6% is the optimal number to may way of thinking. So, based on a $200,000 salary, that'd make your 401k contribution about $12,000.  But wait the plan says that you can put as much as 10% of your salary away, or roughly $20,000 but you'd be capped at the max contribution under the tax law of $18,000 but that's still another $6k that you could stuff into the plan, so why not?

I'm not saying that you shouldn't save that $6k, but frankly, I think a personal investment account outside of the retirement realm might be a better option;

  • First, if you build a portfolio correctly and avoid actively managed mutual funds or sticking the money into an annuity of some sort, you'll have a small if any, annual income tax bill
  • When you withdraw money from your personal account, you'll pay capital gains taxes at about half the rate of income tax you'll pay on 401k withdrawals. It takes a long time for the tax deferral advantage of a 401k deposit to offset what could be a 100% increase in post retirement tax rates
  • If you retire earlier or choose to work in a different job and need some additional dollars each year to float the household cash flow; you'll have access to funds a personal account that don't require premature tax payments to the IRS. Remember, the IRS forces you to take retirement plan distributions but only when you're 70 and 1/2, anything before that means your coughing up tax dollars that the government isn't really asking for
  • You'll have more, infinitely more investment options outside of your 401k and they'll be infinitely cheaper than the ones your company retirement plan offers in almost circumstance

Retirement plans are like annuities, or municipal bonds or another other financial instrument, when they're over used or solely used, there's likely to be problems that follow.

We're enticed by the write off that putting money into a retirement plan affords us and sometimes, if not many times, to a fault.