The unfortunate truth about maxing out your 401(k)

Millions of us have 401(k) accounts, sponsored by our employers or former employers. And hundreds of thousands, if not millions, of us actually have accounts worth $1 million or more. That's not the norm — millionaire accounts only made up about 1.8% of 401(k) accounts administered by Fidelity, for example. But Fidelity's recent 422,000 millionaire 401(k) accounts do show us how powerful a retirement saving tool 401(k)s can be.

Despite that, though, there's an unfortunate truth about 401(k) accounts: They may not be your best path to growing your wealth for retirement.

Upsides and downsides to 401(k) accounts

401(k) accounts, which debuted in 1980, have some fantastic features — but they're not perfect. Here are some of their pros and cons.

Advantages of 401(k) accounts:

• They sport hefty contribution limits. In 2024, the contribution limit is $23,000 (up from $22,500 for 2023), plus an additional $7,500 "catch-up" contribution for those 50 or older. (The IRA contribution limit, meanwhile, is $7,000, plus a $1,000 catch-up contribution.)
• Your account gets automatically funded from every paycheck, once you set it up. That can be handy for those who might otherwise put off saving for retirement or simply forget to do so.
• Many employers offer matching contributions, chipping in money into your account along with you. (It's usually smart to contribute enough to grab the maximum match, as it's free money.)
• Money in your 401(k) account grows in a tax-advantaged way — either by postponing taxation via a traditional 401(k) or by avoiding it altogether via a Roth 401(k).

Drawbacks of 401(k) accounts:

• A 401(k) account alone may not help you save as much as you need for retirement.
• Not everyone has access to a 401(k) plan at their workplace. (They may be able to take advantage of retirement accounts for the self-employed, and they can probably save via IRAs, too.)
• You're limited in where you can invest your 401(k) dollars. You typically have only a large or small handful of funds to choose from. (If a low-fee, broad-market index fund, such as one tracking the S&P 500, is one of your options, that can work quite well.)
• Some 401(k) accounts charge relatively steep fees, which can eat into your returns. It's always smart to find out what kind of fees you'll face.
• Funds in your 401(k) can't be withdrawn any time you'd like without triggering taxes and penalties. To avoid penalties, you'll generally have to wait until age 59 1/2 — and unless your money is in a Roth 401(k) with tax-free withdrawals, your withdrawals will count as taxable income.
• Once you approach or reach age 73, you'll be required to start taking required minimum distributions (RMDs) annually from a traditional 401(k) — and a traditional IRA, as well.
• If your 401(k) is the traditional (not Roth) kind, your withdrawals will be taxed — which could be bad news if you're in a higher tax bracket in retirement than you were when you made your contribution.

Why you might not want to max out your 401(k)

Here's a common scenario: You earn a certain sum, and the amount you can contribute to your retirement account(s) is, naturally, limited. Let's assume that you're able to sock away a hefty $25,000 each year.

You can save that $25,000 for retirement in different ways. For example, you can park up to $7,000 or $8,000 in an IRA, you can add some or all of that $25,000 to your regular, taxable brokerage account, you can send some or all of it to one or more mutual funds (either directly, via the fund company or through your brokerage account), and/or you can contribute up to $23,000 (or $30,500 if you're 50 or older) to your 401(k). See? Lots of possibilities.

So what should you do? Well, there are plenty of reasonable and effective choices, but keep these thoughts in mind:

• If your 401(k) plan doesn't offer a low-fee, broad-market index fund or whatever kind of investment you want, consider not maxing out your contributions to it. (You might also ask the plan administrator to consider adding the investment options you seek.)
• Within an IRA account, you can invest in just about any mutual fund out there, and just about any stock(s). If you have great confidence in your ability to invest your money effectively —perhaps by investing in growth stocks such as Amazon.com (NASDAQ: AMZN), Google parent Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL), or Nvidia (NASDAQ: NVDA) — you may be able to do better within an IRA or a regular, taxable brokerage account than in a 401(k).
• If you think you might need or want to withdraw some money before retirement, remember that you could face an early withdrawal penalty doing so from a 401(k) plan or an IRA — but not from a regular, taxable brokerage account.
• Above all, remember that you can divide your $25,000, perhaps maxing out your IRA account first and then distributing the remainder across your 401(k) and one or more other accounts.

It's worth taking some time to determine how you want to invest your retirement savings each year. You might also read up on more 401(k) mistakes to avoid, in order to get the most out of your retirement savings accounts.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Selena Maranjian has positions in Alphabet, Amazon and Nvidia. The Motley Fool has positions in and recommends Alphabet, Amazon and Nvidia. The Motley Fool has a disclosure policy.

The Motley Fool is a USA TODAY content partner offering financial news, analysis and commentary designed to help people take control of their financial lives. Its content is produced independently of USA TODAY.

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