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Catch-up contributions are a great way for older workers to add extra money to their retirement accounts, helping them increase their savings at a critical time. After years of paying for children, a house and other vital expenses, catch-up contributions allow older workers to get back on track in building their nest egg.
Here’s how catch-up contributions work and how they can help you build a better retirement.
What are catch-up contributions and who can make them?
Catch-up contributions allow workers with employer-sponsored retirement plans such as a 401(k) or 403(b) to add extra money to their accounts. The catch? You have to be at least 50 years old to make them, meaning you have limited time to do so before you retire.
The 401(k) contribution limit for 2023 is $22,500, and the catch-up contribution allows workers to add an additional $7,500 – for a grand total of $30,000 each year.
That’s a lot of money, and this amount could be difficult to save, since it represents more than 25 percent of the annual salary for a worker earning $100,000 per year and, obviously, a much larger percentage for those earning less.
Fortunately, almost all employers offer catch-up provisions in their retirement plans, so most workers have the opportunity to make these contributions. Vanguard’s 2022 How America Saves report found that in 2021 a whopping 98 percent of plans offer catch-up contributions.
However, only 16 percent of all participants used this enhanced savings opportunity, a percentage that has remained relatively unchanged since 2016. Not surprisingly, this percentage was significantly higher for higher wage earners – 60 percent of participants with an income of more than $150,000 made catch-up contributions in 2021.
It’s worth noting that IRAs also allow those age 50 and over to add an extra $1,000 each year on top of the regular contribution limit, which is $6,500 for 2023.
For workers who can take advantage of the catch-up provision based on their age and income, it may make sense to do so, even if it means revising family budgets, foregoing extra vacations or splurge purchases in exchange for the opportunity to enhance your future financial position.
Top reasons to take advantage of catch-up contributions
- They can be made pre-tax. Catch-up deductions can be made pre-tax, which has the effect of reducing taxable income, perhaps significantly, depending on your tax bracket. If you make catch-up contributions on a pre-tax basis, Income tax will not be due on that money until it is withdrawn from your 401(k) in retirement – at which point you may be in a lower tax bracket.
- Enhanced compounding. While an exact prediction of how much the extra contributions from age 50 to 65 could add to your retirement nest egg is not possible, especially during times of market volatility, the compounding effect on fifteen years of catch-up contributions of more than $100,000 can help to close the gap between projected expenses and projected cash flow during a typical 20- to 25-year retirement.
- Automatic withdrawals. Catch-up contributions are made automatically through elective salary deferrals just like regular 401(k) deferrals.
- Contributions to a Roth account. Catch-up contributions can also be made to Roth 401(k)s or split between traditional and Roth 401(k) accounts. While your tax break is not immediate with a Roth 401(k), you are eligible to make tax-free withdrawals in retirement.
- Accelerated savings for late savers. Catch-up contributions are crucial if you are just starting to prepare for retirement in your fifties or if you need to rebuild your retirement savings for any reason.
- Contributions all year long. You can begin your catch-up contributions in the calendar year you turn 50 – you do not have to wait until your birthday. So you’re able to spread out your contributions across the year.
- Access to an employer match. Your catch-up contributions may be eligible for an employer match. Check with your human resources department for the specifics of your plan.
- Increase to available balance. Catch-up contributions are considered part of your available balance when requesting a loan or hardship withdrawal from your 401(k).
- Breathing room for splurges. If you are on track with your retirement goals, taking advantage of the catch-up provision can help you exceed your goals, allowing you to comfortably take that extra vacation or splurge on a big purchase.
Impact of SECURE Act 2.0 on catch-up contributions
The passage of SECURE Act 2.0 at the end of 2022 made a few changes to catch-up contributions. Here are the key changes:
- Starting in 2024, if you make more than $145,000, catch-up contributions can only be made after taxes to a Roth account.
- Beginning in 2024, the catch-up contribution limits for IRAs will be indexed for inflation, meaning it could increase every year depending on cost of living increases.
- Beginning in 2025, there will be a special catch-up contribution limit for employees aged 60-63. The limit is the greater of $10,000 or 150 percent of the regular catch-up limit in place for the taxable year.
In drafting the legislation, Congress accidentally deleted the provisions that allow for catch-up contributions at all and, if not corrected, the contributions would not be allowed after 2023. But it’s widely expected that Congress will correct the error.
Catch-up contributions can offer a great ability for older workers to add extra money to their retirement accounts, whether they’ve saved throughout their working life or really do need to catch up. With older Americans living longer than ever before, it’s valuable to ensure that you’ve built up all the wealth you need for potentially decades in retirement.