Catch-Up Contributions

As you get nearer to retirement age, you might look back on the financial decisions you made in your younger years and wonder what you were thinking. Knowing what you know now about how savings grow over time, you might be wishing that you contributed more to your 401(k) or similar plan or that you opened an IRA earlier.

If you do not think you are on track when it comes to retirement savings or you’re afraid of making common retirement mistakes, you are in good company. About 44% of non-retired adults believe that they are not on track when it comes to retirement. About 25% of non-retired adults have no retirement savings and about 13% of people over age 60 who are still working have nothing saved for retirement.

What can you do if you’re getting closer to retirement and do not think you’ll have enough saved to live comfortably once you stop working? There are contribution limits on tax-advantaged retirement savings accounts, such as IRAs and 401(k) plans. Once you reach the age of 50, the IRS lets you make catch-up contributions, meaning you can deposit more in your retirement account than people under age 50.

What Are Catch-Up Contributions?

Catch-up contributions are a way to make up for lost time. From the age of 50 on, you can contribute more to a 401(k), 403(b),457(b), Simple 401(k) or IRA than you could as a younger person. How much you can contribute depends on the type of account you have.

What Are Catch-Up Contributions for a 401(k) or 403(b)?

If you have an employer-sponsored retirement plan, it’s likely a 401(k). If you work for a non-profit, you might have a 403(b), which is similar to a 401(k). The contribution limit or standard elective deferral for a 401(k) or 403(b) for both 2019 and 2020 is $19,000.

Should you turn 50 before the end of the fiscal year, you can begin to make catch-up contributions to your 401(k) or 403(b). With a 403(b) plan, you can also begin making catch-up contributions after 15 years of service if you work at one of the following:

• A church
• A public school system
• A hospital
• A health and welfare service agency
• A home health service agency

For both a 401(k) and 403(b), the catch-up contribution limit is $6,000 for 2019 and 2020 for people who are 50 or older. For employees with a 403(b) and at least 15 years of service, the catch-up contribution limit is $3,000.

What Is an IRA Catch-Up Contribution?

An individual retirement arrangement (IRA) is a type of tax-advantaged retirement savings plan designed for people who either do not have a retirement plan through their employer or who are looking to supplement their retirement savings. Generally, two types of IRA exist — traditional and Roth. There are rules and restrictions for each type of IRA based on your income level and whether an employer-sponsored plan is available to you or not.

Contribution limits for IRAs are considerably smaller than they are for employer-sponsored plans. For 2019 and 2020, the contribution limit is $6,000. If you are over the age of 50, you can contribute an extra $1,000 to an IRA, bringing your total allowed contribution to $7,000.

What Are Catch-Up Contributions for SIMPLE IRA or 401(k) Plans?

Your employer might offer a SIMPLE IRA plan, or you might be a self-employed person or small business owner with a SIMPLE 401(k). If that’s the case, the catch-up contribution rules are slightly different compared to other types of 401(k) or IRA. For both a SIMPLE IRA or SIMPLE 401(k), the catch-up contribution limit is $3,000.

What Are the Benefits of Catch-Up Contributions?

Whether made to a 401(k), IRA or another retirement plan, catch-up contributions have several advantages. The first advantage is that being able to save more for retirement as you get nearer to it means you’re more likely to reach your retirement goals. If you plan on retiring at age 70, saving an extra $6,000 per year for 20 years can make a significant difference in the amount you have in your nest egg.

Catch-up contributions can also help you save on taxes in the year you make the contributions. The money you save into a 401(k) or 403(b) is deducted from your taxable income for the year when you make the contribution. If you save money in a traditional IRA, you can also deduct the amount of your contributions from your taxable income during the year when you make the contribution.

If you have a taxable income of $90,000 and you save the full $25,000 allowed to your 401(k) — $19,000 regular contribution plus $6,000 catch-up — you can reduce your taxable income to $65,000. You would pay tax on less money, and your tax rate would also fall. For 2019, the tax rate for income over $84,200 for a single person is 24%. The tax rate for income between $39,476 to $84,200 is 22%. By lowering your taxable income to $65,000, you’d fall into the 22% tax bracket.

How Do I Make Catch-Up Contributions?

How you make a catch-up contribution depends on the type of plan you have. If you want to contribute the extra $1,000 allowed to a traditional or Roth IRA, it can be as simple as signing into your account and depositing $1,000 into it.

If your employer sponsors your retirement plan and the contributions come directly from your paychecks, you’ll want to get in touch with the plan administrator or your company’s human resources department to see about increasing your contributions. Before you do so, it’s a good idea to confirm that contributing more to your retirement works with your budget. If you already contribute the maximum, plan on contributing the full $6,000 and get paid monthly, you’re looking at an extra $500 out of your paycheck each month.

You can start making catch-up contributions in the year you turn 50, so even if you’re 49 at the start of the fiscal year, you can begin to make extra contributions to your retirement plan.

Depending on your income and cost of living, contributing an extra $6,000 to your 401(k) or 403(b) plan might not seem feasible. Even if you can’t contribute the full amount, you might still be able to save a bit more once you’re 50. Saving an extra $1,000 or $2,000 per year can make a difference.

Are There Any Limits to Catch-Up Contributions?

Although making catch-up contributions can help you reach your goals for retirement, it is important not to go overboard when it comes to saving money. If you go over the $6,000 catch-up contribution limit for a 401(k) or 403(b), you risk being taxed on the excess amount. You might also have to pay an additional penalty tax on the excess contribution. You can avoid the penalty tax by removing the excess contribution from your retirement plan by the tax filing deadline, but you will still need to pay income tax on the amount.

Work With a Fee-Only Firm as You Plan for Retirement

HSC Wealth Advisors has been serving in Virginia and neighboring states since 1983. As a fee-only firm that follows a fiduciary standard, we do not receive a commission from investment companies and only recommend investments that we believe will truly be in the best interest of our clients.

To learn more about our services and how we can help you plan for retirement, including planning for catch-up contributions once you are over the age of 50, contact us today.