An Overview of Catch-Up Contributions

If you’re age 50 or older but didn’t save enough money for retirement when you were younger, you’ll be happy to know the IRS established rules to help make up for this shortfall via “catch-up contributions”: additional contributions you can make to your 401(k) and IRA accounts above the standard limits.

Even if you’ve saved enough money but want to maximize the amount you’re contributing to your retirement accounts (good for you!), you too can take advantage of the laws surrounding catch-up contributions. Let’s dive into this beneficial opportunity.

How catch-up contributions work

The IRS sets catch-up contribution amounts on an annual basis, and limits vary based on your retirement plan. What’s more, you can begin making catch-up contributions at any point during the calendar year when you turn 50; in other words, there’s no need to wait until your actual birthday as you’re eligible beginning January 1st of that same year. Here’s a breakdown for each investment type based on 2023 contribution limits:

·      IRAs: $1,000 catch-up contribution, resulting in a total contribution of $7,500 (the standard limit is $6,500)

·      401(k)s: $7,500 catch-up contribution, resulting in a total contribution of $30,000 (the standard limit is $22,500). This also applies to other workplace retirement vehicles such as 403(b)s, most 457s, and the government’s Thrift Saving Plan (TSP).

·      SIMPLE 401(k)s: $3,500 catch-up contribution, resulting in a total contribution of $19,000 (the standard limit is $15,500)

Upcoming Secure Act 2.0-driven changes

The Secure Act 2.0 was signed into law in December 2022, resulting in sweeping changes to retirement plans—including catch-up contributions. One key provision is that annual IRA catch-up contributions will be adjusted annually for inflation beginning in 2024. Then in 2025, employees between the ages of 60 and 63 will receive a “special” catch-up contribution limit for most 401(k)s and other employer-sponsored plans. More specifically, this equates to $10,000 (or 150%) of the standard contribution limit (whichever is greater) for 2024. The $10,000 amount will also be adjusted for inflation each year beginning in 2026.

If you earn more than $145,000 from an employer in 2026 and contribute to an employer-sponsored plan—such as a 401(k), 403(b), or 457(b)—you must make catch-up contributions to a Roth version of your respective retirement plan beginning in that same year: meaning you’ll pay taxes on your catch-up money upfront rather than contributing pre-tax money, as you can now. However, you won’t need to pay taxes on the money or its earnings when you withdraw later in life—and if your employer doesn’t offer a Roth version of your plan, you can’t make any type of catch-up contribution to the same. Beginning in 2024, RMDs will no longer be required for Roth account versions of your plan.

Meanwhile, catch-up contribution limits for SIMPLE plans will increase by 10% starting in 2024; beginning in 2025, account holders between the ages of 60 and 63 will also receive a “special” limit of $5,000 (or 150%) of the 2025 catch-up contribution limit (whichever is greater) for other eligible workers. This amount will also be adjusted for inflation on an annual basis.

Reasons to make catch-up contributions

Data recently compiled via a Vanguard 401(k) plan analysis revealed that only 16% of plan participants take advantage of catch-up contributions even though almost all plans (98%, in fact) offer this option. While the primary driver of this weak uptake is affordability (workers simply don’t earn enough income to do so), even a little extra savings can make a significant difference for your future.

How much you can expect to gain ultimately depends on various factors, however: including the type of plan, how much extra you contribute, and your rate of return. Let’s assume you just turned 50 and your goal is to retire at age 66. While planning to cut a few expenses, you determine you can afford to contribute an extra $250 a month to your 401(k). Assuming your annual rate of return is a conservative 4%, this would land an additional $67,000 in your retirement portfolio!

Also important to keep in mind? Retirement is expensive. The Bureau of Labor Statistics recently revealed that average retiree expenses (in households led by someone aged 65+) total over $52,141 per year (about $4,345 per month). Unfortunately, these numbers only grow for those further away from retirement. The point is that every dollar you save now can only stand to benefit you in your later years.

Another benefit of catch-up contributions—especially if you’re contributing to a 401(k)—is that you can potentially ease your tax bill, as the extra money you sock away will reduce your taxable income.

Reasons to consider holding off on catch-up contributions

Making a catch-up contribution is perhaps not in your best interest if you’re already taking withdrawals from a retirement account, need the extra money for other savings goals/to cover essential expenses, or feel confident you’re already saving enough.

How to make catch-up contributions

If you have an IRA account, you’ll need to contact the account custodian and indicate you want to make catch-up contributions: keeping in mind you are not required to do so by the end of the calendar year for IRAs, unlike for 401(k)s. As the deadline often falls in mid-April (Tax Day) of the following year, anyone wishing to make catch-up contributions for an IRA in 2023 should therefore circle April 15, 2024 on their calendars.

If you elect to make catch-up contributions to your 401(k) account, meanwhile, ensure your plan allows for it. From there, you’ll need to contact your benefits department or plan administrator and likely provide authorization to implement your plan.

In sum: catch-up contributions

Catch-up contributions are often a great strategy to save additional money for your future. Therefore—if it makes sense for your overall financial plan—seek to take advantage of this opportunity to give yourself the best chance to enjoy retirement to its fullest.

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.