In the case of password storage, consider the following:
I have an idea that one can exhaust the entropy of input to the MD5 function by using a 128 bit random value as the password (indeed, any hash function, using the output length as input). Is this a correct assumption, or is the entropy exhausted at 123.4 bit, this being the best attack to date? Or does this only apply to hash functions that for every value in the interval $[0, 2^{L}]$ provide another unique value in the same interval?
I hope you understand what I'm trying to ask here - I see that I have a hard time explaining it clearly. What I want to do with this idea is argue that in the case of MD5 stored passwords, there is no reason to use passwords with a higher entropy than the hash itself.