Earning a healthy six-figure income, James and Michelle have been diligently maxing out their 401(k) contributions for the past few years.
But is contributing the maximum $23,500 to a 401(k) always the best strategy? Not necessarily. Let’s jump into why.
Finding the Right Savings Balance
While James and Michelle’s 12% total savings rate (Sr) is solid, there’s room for improvement given their income level. A savings rate closer to 15-20% would set them up for even greater financial security. And given their higher income, there is likely room to do so.
However, their current approach of funneling most of their savings into tax-deferred retirement accounts has left their liquid term (Lt) at just 0.3. This means they have less than 6 months worth of living expenses available in cash.
The Importance of Liquidity
Having accessible savings outside of retirement accounts provides crucial flexibility for:
- Emergency expenses
- Major purchases
- Career transitions
- Investing opportunities
Tying up too much in 401(k)s limits your ability to adapt to life’s curveballs without incurring early withdrawal penalties.
The Sweet Spot
For James and Michelle, the ideal path forward is:
- Continue contributing enough to get the full 5% employer 401(k) match. That’s free money!
- Redirect the amount over the match to building liquid savings until they have 6-12 months of expenses saved (Lt of 0.5 to 1.0). Remember, this money doesn’t have to sit in cash, this can be money invested outside of retirement still earning a good return.
- Revisit increasing 401(k) or other retirement contributions once they built up their Lt to about a 1.0.
- Challenge themselves to boost their overall savings rate to 15%+ to supercharge wealth-building.
This strategy allows James and Michelle to take advantage of the employer match while maintaining the liquidity to navigate life’s opportunities and challenges with confidence.
When James and Michelle hit an Lt score of 1.0, we recommend they meet with a coach to determine a new strategy for their funds.
Want personalized guidance on turbocharging your savings? Schedule your free coaching session to get started!
