Retirement Account Catch-Up Contributions Can Add Up

November 13, 2017

Are you age 50 or older? If so, you can currently make extra “catch-up” contributions to certain types of tax-favored retirement accounts. Over time, these contributions can make a significant difference in your retirement-age wealth.

What about tax reform? After President Trump and other lawmakers stated that they wouldn’t tinker with retirement plan contribution tax breaks, the U.S. Senate has proposed limits to catch-up contributions. These are just proposals. For now, the rules in this article are current law.

Unfortunately, many people are unaware of this retirement savings bonus. Here’s what you need to know to reap the benefits.

The Basics

Eligible taxpayers can make catch-up contributions to a traditional IRA or a Roth IRA. In addition, some employer-sponsored retirement plans allow participants to make catch-up contributions.

IRA catch-up contributions. Once you reach age 50, you can make extra catch-up contributions of up to $1,000 annually to your traditional IRA or Roth IRA. If you’ll be 50 or older as of December 31, 2017, you can still make a catch-up contribution for the 2017 tax year. You have until April 16, 2018, to make your contribution.

Tax-deductible contributions to traditional IRAs create tax savings, but your income may be too high to qualify. Contributions to Roth IRAs don’t generate any upfront tax savings, but you can take federal-income-tax-free withdrawals after age 59 1/2 (assuming you’ve had at least one Roth account open for over five years).

There are income restrictions on Roth contributions, too. Worst case, you can make extra nondeductible traditional IRA contributions and benefit from the account’s tax-deferred earnings advantage.

Catch-up contributions to employer-sponsored plans. If your employer’s retirement plan allows extra salary reduction contributions and you’ll be age 50 or older at the end of next year, you can contribute up to $6,000 in added savings for 2018 to your 401(k), 403(b) or 457 account.

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 get a state income tax deduction, too.

You can use the resulting tax savings to help pay for part of your catch-up contributions. Or you can set the tax savings aside in a taxable retirement savings account to further increase your retirement-age wealth.

Having trouble deciding which tax-favored account to make extra contributions to? In a nutshell, making deductible catch-up contributions to a traditional IRA or to an employer-sponsored retirement plan will lower your tax bills. Contributing extra to a Roth IRA won’t lower your taxes, but you can take more tax-free withdrawals later in life.

Retirement Savings Bonus

How much extra could you accumulate just by making catch-up contributions? The extra savings quickly add up, because maximum catch-up contributions are considerably larger than they once were.

For example, the maximum catch-up contribution to a 401(k) account was only $1,000 in 2002 vs. $6,000 for 2018. The maximum catch-up contribution to an IRA was only $500 in 2002 vs. $1,000 for 2017 and 2018.

To illustrate how much catch-up contributions can add to a retirement nest egg, suppose Beth, who’s currently 50, decides to contribute an extra $1,000 to her IRA in 2017. She contributes an extra $1,000 each year through 2032. By age 65, Beth will have accumulated roughly $30,000 more in savings (assuming an 8% annual return).

Alternatively, let’s suppose that Beth decides to contribute an extra $6,000 to her 401(k) plan each year through age 65, starting in 2018. In that case, by age 65, she’ll accumulate roughly $182,000 in additional savings (assuming an 8% annual return).

To maximize your savings, you can make catch-up contributions to both your IRAs and employer-provided retirement plans in the same year. In the hypothetical example, Beth’s combined savings could add up to $212,000 by age 65 (assuming an 8% annual return), if she contributed to $1,000 extra to her IRA annually (starting in 2017) and $6,000 to her 401(k) annually (starting in 2018).

Deadlines

There’s still plenty of time to make an extra catch-up contribution of up to $1,000 to your IRA for the 2017 tax year. The 2017 IRA contribution deadline is April 16, 2018. Then you can make another IRA catch-up contribution for your 2018 tax year anytime between January 1, 2018, and April 15, 2019.

If you are an employee and your employer-sponsored qualified retirement plan allows catch-up contributions, you can sign up to make them for 2018 year during this year’s open enrollment period that is probably already underway at your job. Or your employer may allow you to modify your contributions any time during the year, which means you might still be able to do it for this year. Check with your benefits department to see what your options are.

Contact your tax advisor if you have questions or want more information about retirement account catch-up contributions.

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