Use Catch-Up Contributions to Bolster Retirement Savings
If you’re age 50 or older, you can make extra “catch-up” contributions to certain types of retirement accounts. Many people fail to capitalize on this opportunity because they haven’t looked at the significant impact these extra contributions can have on their retirement-age wealth.
If you’re worried that you won’t have enough money saved to be financially comfortable in retirement, your worry may be justified. As you’ll see, making catch-up contributions can help alleviate that concern. Here’s what you need to know about the catch-up contribution “fix.”
IRA Catch-Up Contributions
Once you’ve reached age 50, you can make extra catch-up contributions of up to $1,000 annually to your traditional IRA or Roth IRA. You have until April 15, 2024 to get it done for your 2024 tax year. Contributions to deductible IRAs create tax savings, but your income may be too high to qualify.
Catch-up contributions to Roth IRAs don’t generate any upfront tax savings, but you can take federal-income-tax-free qualified withdrawals after age 59½ if you’ve had at least one Roth account open for more than five years. There are income restrictions on Roth contributions, too. Worst case: you can make nondeductible traditional IRA catch-up contributions and benefit from the account’s tax-deferred earnings advantage.
Company Plan Catch-Up Contributions
For 2024, you can make salary-reduction catch-up contributions of up to $7,500 to your 401(k), 403(b) or 457 account, if:
- The company plan allows them, and
- You’ll be age 50 or older as of year end.
Salary reduction contributions are subtracted from your taxable wages, so you effectively get a federal income tax deduction. If your state has a personal income tax, you’ll generally also get a state income tax deduction.
You can use the resulting tax savings to help pay for part of your catch-up contribution, or you can set the tax savings aside in a taxable retirement savings account to further increase your retirement-age wealth.
Important: To be abundantly clear, the advantage of making these catch-up contributions is that they reduce your taxable salary while also allowing you to put more into your company plan retirement account for the future. That’s a tax-smart double play.
Designated Roth Account Catch-Up Contributions
Your company plan may offer the Designated Roth Account (DRA) option. Assuming the plan permits them, you can make catch-up contributions to your DRA. However, these contributions are after-tax, so they don’t reduce your taxable wages. On the plus side, DRA balances can grow federal-income-tax-free, and qualified distributions taken from DRAs are federal-income-tax-free. A qualified distribution is one that: (1) occurs at least five years after your first contribution to the DRA and (2) is made after reaching age 59½ or due to disability or death.
How Much Extra Could You Accumulate?
Making catch-up contributions can quickly add up, because the maximum amount is considerably higher today than it has been historically. For example, in 2002, the maximum catch-up contribution to a 401(k) account was only $1,000 versus $7,500 for 2024. The maximum catch-up contribution to an IRA was only $500 versus $1,000 for 2024.
Consider the following examples to understand how much additional retirement-age wealth you could accumulate by making catch-up contributions.
IRA catch-up contributions. Suppose you’re age 50, and you contribute an extra $1,000 to your IRA this year and then do the same for the next 15 years, through age 65. Here’s how much extra you could have in your IRA by age 65 (rounded to the nearest $1,000):
4% Annual Return-$22,000
6% Annual Return-$26,000
8% Annual Return-$30,000
Making larger deductible contributions to a traditional IRA can also lower your tax bills if your income qualifies. Making additional contributions to a Roth IRA won’t affect your tax bill, but you can take more tax-free withdrawals later in life.
Company plan catch-up contributions. Suppose you’ll turn 50 next year, and you contribute an extra $7,500 to your company plan for next year. Then you do the same for the following 15 years, through age 65. Here’s how much extra you could have by age 65 in your 401(k), 403(b) or 457 plan account or Designated Roth Account (DRA) (rounded to the nearest $1,000):
4% Annual Return-$164,000
6% Annual Return-$193,000
8% Annual Return-$227,000
Finally, if you’ll turn 50 next year, you could make the maximum catch-up contributions to both an IRA and a company plan for each year, through age 65. Here’s how much extra you’d have in your retirement savings by age 65 (rounded to the nearest $1,000):
4% Annual Return-$186,000
6% Annual Return-$218,000
8% Annual Return-$258,000
Catch-Up Contribution Changes for 2025 and Beyond
The SECURE 2.0 Act updated your retirement savings opportunities. Here are two provisions that you might want to keep on your radar if you’re interested in making catch-up contributions.
First, the law includes a provision that raises the limits on retirement account catch-up contributions, starting in 2025, for retirement plan participants who attain age 60 through 63 during the year in question. For qualifying individuals, the maximum catch-up contribution will increase to the greater of:
- $10,000 (adjusted for inflation), or
- 150% of the 2024 maximum “regular” catch-up contribution amount.
So, for those ages 60 through 63, the maximum catch-up contribution for 2025 will be at least $11,250 (150% of $7,500).
For all other participants who are eligible to make catch-up contributions, including those who will attain age 64 or older during the year in question, the “regular” catch-up contribution maximum explained earlier ($7,500 for 2024 with inflation adjustments for later years) will continue to apply.
The second noteworthy provision targets catch-up contributions for higher-income retirement plan participants. This change, which was supposed to take effect in 2024, would have affected catch-up contributions for participants in 401(k), 403(b) and 457(b) plans whose prior-year wage income exceeded $145,000 (as adjusted for inflation). Under the provision, these higher-income participants would have been allowed to make catch-up contributions only to company-sponsored Designated Roth Accounts (DRAs).
DRA contributions are after-tax, so they don’t reduce the participant’s taxable salary. On the plus side, DRA account balances can grow federal-income-tax-free, and qualified distributions taken from DRAs are federal-income-tax-free. A qualified distribution is one that:
- Occurs at least five years after your first contribution to the DRA, and
- Is made after reaching age 59½ or due to disability or death.
Under this provision, if your company’s plan didn’t offer the DRA option and your prior-year wage income exceeded $145,000 (as adjusted for inflation), your ability to make any catch-up contributions to your company account would be eliminated.
This change received significant pushback from employers, retirement plan administrators and higher-income individuals. Thankfully, the IRS granted relief in the form of a so-called administrative transition period. Under the relief, the effective date for the DRA catch-up contribution change was postponed to January 1, 2026. Until then, employers can ignore the change, and higher-income employees can continue to make catch-up contributions to their regular accounts.
Conclusion
As you can see, making catch-up contributions can potentially add up to some big numbers by the time you reach retirement age. If your spouse can make catch-up contributions too, you can potentially double the amounts shown here. That’s certainly something to think about, especially if you have doubts about whether Social Security will be there for you when you need it. Contact your tax advisor if you have questions or want more information about retirement account catch-up contributions.
Copyright 2024
This article appeared in Walz Group’s May 28, 2024 issue of The Bottom Line e-newsletter, produced by TopLine Content Marketing. This content is for informational purposes only.
