Can You Save Too Much in a 401k?

I’m doing something for the first time ever in one of my articles. This will be part one of a two-part email on a specific topic. Hopefully my logic makes sense as I break this topic up. Simply, if I wanted to cover it all in one email it would be dramatically longer than anything I’ve ever written. My goal is to keep these emails short, sweet and to the point. Today’s topic is Can You Save Too Much in Your 401k? Let’s get to part 1.

A few years ago I was at some training. One advisor who presented mentioned he advised clients not to accumulate more than a certain amount in tax-deferred accounts. Basically, 401ks and IRAs. I don’t recall the number, but it was in the upper $700,000 range. His reasoning was a connection between RMDs and the standard deduction. He didn’t get into more detail and I was not able to ask him any follow-up questions. However, and this is the key point – this was the first time I had ever heard of someone saying you could have too much in tax-deferred accounts.  This was sacrilegious to someone raised/trained in the wirehouse world where the goal was to get clients to accumulate as many assets as possible. Why? Well, I’m sure it has nothing to do with the more assets a client has the more the typical advisor gets paid in fees. That is the cynical side of me talking, so let’s get back on topic of whether you can have too much in retirement, specifically your 401k.

Fast forward as this is now a more common topic. You hear it everywhere from radio shows to TikTok videos. Most of the rationale in these formats are flat out stupid to me and/or they just share false information. And I’m not talking about fake news. I mean some of their “facts” are just flat out wrong.

Regardless, I read a solid article a few months back from Nick Maggiuli. His site is called Of Dollars and Data. He puts out some solid articles on a regular basis so I would recommend checking it out and signing up for his stuff.  In this article he tackled the topic of can you save too much in 401ks. Today I wanted to share some of his findings.  You know, I let him do the hard work of the data crunching.

Before we jump into the findings there is one key point I want everyone to understand – If your employer is offering a match to your 401k contribution – GET THAT MATCH!  You know, maybe they put in 4% if you put in 8%. At a minimum, you really, really, really should get that 4% they are contributing.  The question then becomes does it make sense for you to go beyond maxing out their match.  

 The first example Nick used was comparing a Roth 401k to investing directly into a taxable account. As a reminder, contributions to a Roth 401k go in after taxes so there is no immediate tax savings. The money in the Roth 401k grows without taxes and distributions are without taxes assuming you meet the requirements, such as not taking it out before 59 ½. The majority of employers now offer a Roth 401k option. Also, and this is something I remind people of a lot – there is no income phaseout for the Roth 401k. If you make too much to qualify for a regular old Roth IRA, you cannot make too much to participate in a Roth 401k. Finally, a taxable account is simply an account where you contribute money after taxes have been taken out. Also, because it is fully taxable you will have taxes on things like dividends and capital gains.

 Okay, in Nick’s example he used annual contributions of $10,000 to a Roth 401k and $10,000 to a taxable account over a 40-year period of time. Other assumptions are the accounts grow at 5% a year and the taxable account had to pay capital gains taxes of 15% on the 2% annual dividends before they were reinvested. Finally, no sales were made in the accounts as they were just buy and hold for the duration.

 So, what did his data show?  The Roth 401k ended up being worth $150,000 more than the taxable accounts.  Both accounts ended up being worth over $1 million. Not too shabby.  Now, let’s start peeling back the layers of this onion to see some of the findings.

 The Roth was worth $150,000, or 14.5% more than the taxable account. This is after 40 years. The annual rate on that is rather small at 0.34% a year. That’s not too much of a difference. Something Nick and I’m sure some TikTokers would point out – you are tying up your money in a Roth 401k until you retire or at least 59 ½. That is money not available for things like down payment on a house. Yes, I know there are exceptions to where you can access the money in a Roth 401k, but I’m trying to keep this simple.

 Here is the most important point I took from this example – that 0.34% annual difference between the Roth and the taxable could easily be eaten up with higher investment expenses in the Roth 401k plan. His example assumed identical investment charges in both types of accounts. Unfortunately, reality is investment charges in 401k plans are normally higher than in taxable accounts. Last year the average cost for a 401k plan was 0.45%. Odds are investing in an employer-sponsored 401k account beyond getting the Employer match has no long-term benefit than investing directly into a well-managed, buy and hold taxable account. Please go back and read that last sentence again.

 Now, if your 401k fees are lower than average and below the 0.34% difference here, it may be worth participating beyond the Employer match level in the Roth 401k. There are things to take into consideration, such as tying up your money in a 401k and investment discipline.  But that’s a personal decision for you.

 So, the answer to this first part of the question of whether you can save too much in a Roth 401k is you could. At least if the investment expenses in your Roth 401k plan are at or above the average level.

 There are some overall thoughts I will share, however, I will wait until I conclude this topic next week. Stay tuned!

I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.