What does it mean to ‘max out’ your retirement plan?

If there is an upside to the concern of a coming recession, it’s that people get more interested in understanding their personal finances.

I often have a hard time persuading people to save when times are good and their paycheck is steady. But when there’s a downturn in the economy and the stock market swings wildly, they start to worry. Fear can be a powerful motivator to figure out what you don’t know.

During a recent online discussion, a reader admitted to not understanding a key investing strategy — whether it be for retirement or college.

Q: I’ve been a little confused/intimidated when I see people frequently talking about “maxing out” all their various accounts. What do they mean, exactly? When they say they are maxing out what they invest in their kids’ college funds, does that mean parents are contributing the $15,000 they can gift each year? If a family of four is “maxing out” everything, that would add up to a lot of money. And that’s before an emergency fund, a life-happens fund or, you know, buying food and paying for housing and clothes.

A: Let’s go over the numbers.

“Maxing out” in a workplace retirement plan: With 401(k)s, “maxing out” can mean one of two things.

People who say they’ve maxed out in their 401(k) might mean they’ve hit the annual IRS limit allowed for pre-tax contributions. For 2019, the max for employees who participate in a 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is $19,000. Employees 50 or older who have a workplace retirement account can contribute an additional $6,000 — for a total of $25,000 per year — thanks to what’s known as a “catch-up” provision.

But most workers are not maxing out. Fidelity Investments said that out of the employees in the plans the company manages, only 9.1% hit the annual contribution limit in 2018, when it was $18,500. Of the 12.7% who made catch-up contributions, nearly 60% did contribute the full $6,000 allowed.

You’ve probably heard: “Contribute enough to get the maximum company match because that’s free money.” Follow this advice if you can.

Some people say they are maxing out to indicate that they’re putting in enough money to receive the full match offered by their employers.

The average company match, as of the second quarter of this year, is 4.7%, according to Fidelity. The most popular match formula among companies who have their 401(k) with Fidelity is as follows: 100% match up to the first 3% that the employee contributes; then 50% match for the next 2% that the employee contributes.

Fidelity recommends setting a goal to save at least 15% of your pre-tax income each year for retirement, a target that you may be able to reach if your employer’s match is large enough. Keep in mind: The earlier you start to save, the lower your yearly savings rate needs to be, Fidelity points out.

“Maxing out” in a 529 plan: With this college-savings plan, contributions are made after taxes. But earnings are not subject to federal tax — and generally state tax — if they are used for such qualified education expenses as tuition, fees, books, and room and board.

Some folks may be concerned about triggering the federal gift tax with their 529 contributions. But for 2019, the annual exclusion is $15,000, a pretty steep amount for many families. Besides, if you overfund a 529 plan, you risk paying a 10% penalty if the money isn’t used for qualified educational expenses.

When others say they are maxing out their 529 plan, they might mean that they’ve used a college-savings calculator to figure out how much they need to save every year so that neither they nor their child will need to take on student loans. And how much they need to save depends on a lot of factors, such as whether the child plans to go to a public or private college, live on campus or commute.

As to the intimidation factor, there is a lot of financial pressure to stretch your dollars to include saving for retirement or your child’s college education.

However, don’t look at what others are doing. Concentrate on what you can do. Tighten your budget as much as possible and save as much as you can afford. Yes, this may mean you might not retire as early as you want or that your child will stay local to attend college, but that’s OK.

Just like you shouldn’t try to keep up with the spendthrift Joneses, don’t feel like a failure if you can’t match the saving prowess of the super-saver Joneses either.

— Washington Post Writers Group