Top 9 Reasons to Make 401(k) Catchup Contributions
Catch-up contributions are a great way for older workers to add extra money to their retirement accounts, helping them boost their savings at a critical time. After years of paying for children, a house and other vital expenses, catch-up contributions get older workers back on track to build 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 pay them?
Catch-up contributions allow workers with employer-sponsored retirement plans, such as 401(k) or 403(b), to add extra money to their accounts. The problem? You must be at least 50 years old to craft them, which means you have a limited amount of time to do so before retiring.
The 401(k) contribution limit for 2022 is $20,500, and the catch-up contribution allows workers to add an additional $6,500, for a grand total of $27,000 each year.
That’s a lot of money, and this amount could be difficult to save, since it represents more than 25% of the annual salary for a worker earning $100,000 a year and, obviously, a much higher percentage for those who earn less.
Fortunately, nearly all employers offer catch-up provisions in their retirement plans, so most workers have the ability to make these contributions. Vanguard’s 2021 report, How America Saves, found that in 2020, 97% of plans offer catch-up contributions. However, only 15 percent of all participants used this enhanced savings opportunity, a percentage that has remained relatively unchanged since 2016. Unsurprisingly, this percentage was significantly higher for high earners – 58 percent of participants with a income over $150,000 managed to catch-up dues in 2020.
It should be noted that IRAs also allow people aged 50 and over to add an additional $1,000 each year on top of the regular contribution limit.
For workers who can take advantage of the catch-up provision based on their age and income, this may make sense, even if it means revising family budgets, forgoing extra vacations, or making purchases in exchange for the ability to improve your future. financial situation.
Top reasons to take advantage of catch-up contributions
- Catch-up deductions can be made before 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 If you make catch-up contributions on a pre-tax basis, income tax won’t be owed on that money until it’s withdrawn from your 401(k) upon retirement – at which time – there, you may be in a lower tax bracket.
- While it’s impossible to predict exactly how much additional contributions from age 50 to 65 might add to your retirement nest egg, especially in times of market volatility, the cumulative effect over fifteen years of $100,000 catch-up contributions may help close the gap between projected expenses and projected cash flow during a typical retirement of 20 to 25 years.
- Catch-up contributions are made automatically through elective salary deferrals, just like regular 401(k) deferrals.
- Catch-up contributions can also be made to Roth 401(k) accounts or split between traditional accounts and Roth 401(k) accounts. Although your tax relief isn’t immediate with a Roth 401(k), you can make tax-free withdrawals in retirement.
- Catch-up contributions are crucial if you are just starting to prepare for retirement in your 50s or if you need to rebuild your retirement savings for some reason.
- You can start your catch-up contributions in the calendar year you turn 50 – you don’t have to wait until your birthday.
- Your catch-up contributions may be eligible for employer matching. Check with your human resources department for the details of your plan.
- Catch-up contributions are considered part of your available balance when you request a loan or hardship withdrawal from your 401(k).
- If you’re on track to meet your retirement goals, taking advantage of the catch-up provision can help you exceed your goals, allowing you to comfortably take an extra vacation or splurge on a big purchase.
The future of catch-up contributions
Those focused on saving for retirement should keep an eye out for future developments that may affect their ability to save even more.
Congress is currently considering two separate bills that could potentially make changes to the system. A bill would increase the annual catch-up limit for workers aged 62 to 64 while paying after-tax contributions only. The other version would increase the limits for workers aged 60 and over, but would not change the tax treatment of these contributions.
Whether or not these changes become law, there’s no better time than the present to consider maximizing your 401(k) contributions and catch-up provision if you’re financially able to do so.
At the end of the line
Catch-up contributions can provide a great ability for older workers to add extra money to their retirement accounts, whether they’ve been saving throughout their working life or really need to catch up. With older Americans living longer than ever before, it’s important to make sure you’ve accumulated all the wealth you need for decades in retirement.