Why Maxing Out Your Retirement Fund May Hurt Your Finances netflix free account 2020

If there’s one piece of financial advice that is touted ad nauseam, it’s that it’s crucial to save as much as you can to prepare for retirement.

There’s a good reason why this advice is thrown around so often. Approximately 45% of baby boomers have no savings at all, according to a report from the Insured Retirement Institute, and of those who do have savings, more than a quarter have less than $100,000 socked away. Considering you may spend several decades in retirement, that money won’t go very far.

It may seem, then, that the logical thing to do if you’re behind on your savings is to start loading your 401(k) or IRA with as much money as possible. In some cases, that’s a smart move. But sometimes, maxing out your retirement fund can do more harm than good.

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Image source: Getty Images.

When saving more isn’t the best idea

In general, saving more for retirement is a smart use of your money. But if you’re neglecting your other financial priorities in the process, you may end up hurting your finances over the long run.

Besides saving for retirement, two important money goals you may have include paying down debt and establishing an emergency fund. If you’re failing to pay down high-interest debt or don’t have a penny set aside in a rainy day fund, it may be a good idea to focus on those goals before you throw all your extra cash into your retirement fund.

High-interest debt is incredibly toxic, and the average credit card interest rate hovers just above 17% per year. Meanwhile, your retirement investments may only be earning a 7% to 10% annual rate of return. Depending on how much debt you have and how much you have saved in your retirement fund, there’s a chance you’re paying more in interest on your debt than you’re earning on your investments. In that case, you’re not doing yourself any favors by focusing more on retirement saving than paying off your debt.

It can also be dangerous to max out your retirement fund if you don’t have any emergency savings. Only 61% of U.S. adults have enough savings to cover a $400 unexpected expense, according to research from the Federal Reserve Bank, which means a lot of Americans are at risk of going into debt or tapping their retirement funds to cover unplanned costs. If you withdraw money from your 401(k) or traditional IRA before age 59.5, you’ll typically face a 10% penalty plus income taxes on the amount you take out. So if you don’t have an emergency fund and you’re hit with an unexpected expense, you may end up undoing some of your hard work if you have to withdraw your savings early.

How to balance your financial priorities

It can be tough to figure out exactly where you should put your money, because all of these goals are important. It is vital to save as much as you can for retirement, yet it’s also crucial to pay down debt and establish a healthy emergency fund. So what order should you focus on these goals?

First, if your employer offers matching 401(k) contributions, save enough to earn the full match. Matching contributions are essentially free money, so do your best to take full advantage of them.

Next, take a look at your different types of debt and determine how much you’re paying in interest. Because high-interest debt is the worst offender, that should be the first type of debt you tackle. Lower-interest types of debt — like a mortgage or student loans — are still important to pay off eventually, but you don’t need to put your other goals on hold to do so.

Then, consider how much you want to have saved in an emergency fund. Most experts recommend saving enough to cover three to six months’ worth of living expenses, but anything is better than nothing. So if you can only afford to save a few dollars each week, that’s still beneficial.

Finally, see how much cash you have left over at the end of each month to put toward your goals (after contributing enough to your 401(k) to earn the full match) and decide how much you want to prioritize each goal. If you’re loaded with thousands of dollars of high-interest debt, for example, you may want to put more money toward that and focus less on retirement and your emergency fund. Or if you have lower-interest debt but zero emergency savings, the focus should be more on establishing an emergency fund and saving for retirement.

Once you have the bulk of your high-interest debt paid off and a few thousand dollars stashed in your rainy day fund, you can go full speed ahead on saving for retirement. At this point, you won’t need to worry about debt interest payments overpowering your earnings or risk an unexpected expense eating away at your savings. Your overall financial situation will be much healthier, and you can save more for retirement while still achieving your other financial goals.

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