Catch-Up Contributions Explained
Written by Dan Mules, CPA
According to a Transamerica Center study, only 52% of workers know about catch-up contributions. If you are behind on your retirement savings goal and age 50 or older, you may want to get familiar with this retirement savings strategy.
What Are Catch-Up Contributions?
A catch-up contribution is a retirement savings contribution that allows people age 50 or older to make additional contributions to their 401(k) accounts and/or individual retirement accounts (IRAs) after they reach annual contribution limits established by the IRS.
Amounts & Limits for 2019
IRAs and Roth IRAs: Contribution limit is $6,000 and the catch-up contribution is $1,000.
With an IRA, contributions are tax-deductible in the year they are made. The benefit with regards to RothIRAs is that withdrawals in retirement are not taxed. Also, unless you’re inheriting the Roth IRA, it has no required minimum distribution rules. A Roth IRA also allows you to withdraw contributions (money you put into the account but not earnings) at any time without having to pay income taxes or an early withdrawal penalty.
SIMPLE 401(k): Contribution limit is $13,000 and the catch-up contribution is $3,000.
A SIMPLE 401(k) plan is a hybrid of sorts. It has features of a SIMPLE IRA as well as a traditional 401(k) plan. All employer’s contributions to a SIMPLE 401(k) are subject to the current compensation cap of $280,000, while only non-elective employer contributions are subject to the compensation cap regarding simple IRAs. To be eligible, employers must have no more than 100 employees who have received at least $5,000 in compensation from the employer for the previous year. No non-discrimination testing is required, and it is subject to the 60-day annual notification requirement. An employer may include loans as a feature in a SIMPLE 401(k) plan, unlike the SIMPLE IRA plan.
401(k) and other Employer-Sponsored Retirement Plans (403(b)s, 457s and TSPs- thrift savings accounts): Contribution limit is $19,000 and the catch-up contribution is $6,000.
A 401(k) is a savings and investing plan offered by employers that gives employees a tax break on money they put away for retirement. Contributions are automatically withdrawn from your paycheck and invested in the funds you select before the IRS takes their share, which magnifies the dollars you save. Another benefit these pretax contributions provide is their ability to lower your total taxable income for the year.
403(b) accounts are only available to ministers and employees to nonprofit organizations, public schools, and some hospitals. The 403(b) is favored due to its low administrative costs. Employees with at least 15 years of service may be eligible to make additional contributions to a 403(b) plan in addition to the regular catch-up for participants who are age 50 or over. For 2019, that increased limit is the lesser of either (a) $3,000, or (b) $15,000, minus the amount of additional contributions made in previous years because of this rule, or (c) $5,000 times the number of the employee’s years of service within a given organization, minus total contributions made for earlier years.
A 457 account is a non-qualified, tax-advantaged retirement plan. There are two types. A 457(b) plan is typically available to local and state government workers and employees of tax-exempt organizations. 457(f) plans can be offered to top-level employees and some non-government employees. Contributions are made with pre-tax dollars. There is no 10% penalty for early withdrawals like there is with many other retirement plans. The three-year rule is a unique feature of some of the 457 plans. If you’re within three years of the plan’s normal retirement age, you can save double the annual limit for three years provided you haven’t maxed out your contributions in the past.
Thrift savings accounts are the retirement plans for most federal workers. They provide employees the ability to set aside pre-tax money for retirement. They have extremely low costs, which means only a minimal amount of their retirement savings will get hit for fees and other expenses. Thrift savings plans have both traditional and Roth account characteristics. Employees can choose whether they want to contribute pre-tax money to get an initial tax benefit or after-tax money to reap tax-free treatment in retirement.
If you are 50 or over and have both an IRA and a 401k, you can save an additional $7,000 over the $25,000 you can already save with tax advantages—totaling $32,000. In 2019, total tax-deferred contributions made to your 401(k) plus all other defined contribution plans from all sources (including your employer) is $56,000 or $62,000 if you are age 50 or older.
When to Make Catch-Up Contributions
For 401(k)s, catch-up contributions must be made before the end of the year. IRA catch-up contributions can be made up until the tax filing deadline.
Impact of Catch-Up Contributions
Making extra tax-advantaged contributions can lead to significant results where your retirement savings is concerned, as well as lower your tax bill. Fidelity estimates that by saving a $6,000 catch-up in a 401(k) plan starting at age 50 until retirement, you could add an additional $1,000 per month of income during your retirement. If you contribute an extra $1,000 per year starting age 50 and continue for the next 20 years, with an average rate of return of 7 percent, you could add almost $44,000 more toward your retirement.
To illustrate, imagine you are age 50, and up until now you have saved absolutely nothing towards retirement. You decide this year is the year to get serious. You contribute the maximum amount of $25,000 toward your 401(k) and Roth IRA. If you earn a 7% return per year on that money, you’d have $672,000 by age 65. If you add in the extra $7,000 per year in catch-up contributions, this yields an additional $188,000 in your retirement account.
Call Geier Asset Management Today!
It’s no secret that Americans aren’t saving to the best of their abilities. According to the Government Accountability Office (GAO), around 29% of households age 55 and older don’t have retirement savings or pensions. According to the National Institute on Retirement Security, almost 40 million households have no retirement savings at all! Catch-up contributions are a second chance for those who haven’t taken strides to secure their future retirement. Working with a registered financial advisor to discuss your current savings trajectory is a great first step. Together you can create a savings plan that aligns with your retirement savings goal. Give Geier Asset Management a call at (410) 824-1853 to schedule a time to talk.
Sources: Smart Asset/ Motley Fool/ The Balance/ Fidelity
©Geier Asset Management, Inc. May 2019. Dan Mules, CPA is a Client Manager and Tax Planning Professional for Geier Asset Management, Inc., a Registered Investment Advisor. The articles & opinions expressed in this material were gathered from a variety of sources, but are reviewed by Geier Asset Management, Inc. prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. The views expressed are those of the firm as of May 2019 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Any advice given is general in nature and investors must consider their own individual circumstances. In all cases, please contact your investment professional before making any investment choices. Geier Asset Management, Inc. is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.