How Do 401(k) Catch Up Contributions Work?

Investing News

If your employer offers a 401(k) plan, this can be a very effective way of saving for retirement. The money you put in your plan is “tax-deferred,” so you won’t pay income tax on it for the year you earn it. Instead, you’ll be taxed when you take it out of your 401(k) account during retirement. Since most people are in a lower tax bracket in retirement than they are when they are working, this can save you a lot of money. 

There are annual limits on how much you can contribute to your 401(k) account. In 2022, the limit was $20,500. However, people over 50 can make additional, “catch-up” contributions. Making these catch-up contributions can make all the difference when it comes to retiring comfortably. In this article, we’ll explain how you can make them, and why you should.

Key Takeaways

  • Workers over the age of 50 have a higher annual 401(k) contribution limit than their younger peers. 
  • In 2022, this “catch-up” contribution was $6,500, meaning that those over 50 can contribute a maximum of $27,000 to their 401(k) for that year.
  • If you are already making the maximum contribution to your 401(k), and can afford to increase this, making catch-up contributions can save you a significant amount of money in tax.
  • However, the majority of workers simply do no earn enough to be able to contribute $27,000 a year to their retirement portfolio, and just 15% of 401(k) participants take advantage of catch-up contributions.

Understanding Catch-Up Contributions

There are annual limits to how much you can contribute to your 401(k). In 2022, for people under 50 years old, this limit is $20,500. This limit applies across all the 401(k) plans you have, including any Roth 401(k) accounts. It includes all elective employee salary deferrals as well as any after-tax contributions made to a designated Roth account within your 401(k) or a special Roth 401(k) plan.

The same contribution limits apply to 403(b) plans and most 457 plans, as well as to the federal government’s Thrift Savings Plan (TSP). However, contributions you make to any other type of retirement account, such as a traditional or Roth IRA, don’t count toward the limit.

The only exception to this is once you reach 50 years old. At this point, in order to encourage workers nearing retirement to speed up their savings, the IRS allows 401(k) participants ages 50 and over to make additional contributions beyond the standard contribution limit. If you are over 50, you can make an additional 401(k) contribution of $6,500 a year.

This is known as a “catch-up” contribution, and it applies from the start of the year to those turning 50 at any time during the year. So if you turn 50 on New Year’s Eve, you can still make this extra contribution for that tax year.

If you are aged 50 or over, you can make an additional contribution of $6,500 to your 401(k) per tax year. This will save you tax in the short term, and could make a big difference to the size of your portfolio by the time you reach retirement.

Why You Should Make Catch-Up Contributions

There are a number of advantages to making catch-up contributions, and these are largely similar to the more general advantages of a 401(k) plan. By choosing to contribute more to your 401(k), you will further reduce your tax bill. If you are in a relatively high tax bracket, these savings can be significant: If a worker over age 50 who is in the 35% tax bracket contributes the full $27,000 to a 401(k), they will reduce their current tax bill by $9,450, an extra $2,275 in tax savings in comparison to not making catch-up contributions.

In addition, if you start putting extra money into your 401(k) at age 50 and don’t retire until you are 65 or even older, it can boost the value of your retirement portfolio significantly. You’ll have saved almost an extra $100,000 in those 15 years, and during retirement that could grow still further, depending on the performance of the economy and how your money is invested.

That said, contributing $27,000 a year to a 401(k) is a stretch for many people. Even a worker earning a relatively generous salary of $100,000 per year would have to put aside a quarter of their income, and someone earning $50,000 a year is unlikely to be able to put aside half their income for retirement. 

That is confirmed by the data. Almost all 401(k) plans (97%) permit catch-up contributions, but only 15% of participants take advantage of them when they are offered, according to an analysis of Vanguard 401(k) plans. It is primarily workers with high incomes and large account balances who are able to make catch-up contributions, Vanguard has found.

In other words, if you are already earning a good salary, are on track with your other financial goals, and are bumping up against the 401(k) contribution limit, catch-up contributions can be great. The majority of workers, however, are simply not earning enough to take advantage of the increased limit.

What Is a 401(k) Catch-up Contribution?

Workers over 50 can make an additional annual contribution to their 401(k) plan, over and above the standard $20,500 limit for 2022.

What Is The Maximum 401(k) Catch-up Contribution?

In 2022, the maximum annual 401(k) contribution limit for those over 50 was $27,000. Of this, $20,500 is the standard contribution limit that applies to everyone, and $6,500 is a catch-up contribution.

Should I Make Catch-up Contributions?

If you are earning a good salary, are on track with your other financial goals, and are bumping up against the 401(k) contribution limit, catch-up contributions can be great. The majority of workers, however, are simply not earning enough to take advantage of the increased limit.

The Bottom Line

Workers over the age of 50 have a higher annual 401(k) contribution limit than their younger peers. In 2022, this “catch-up” contribution was $6,500, meaning that those over 50 can contribute a maximum of $27,000 to their 401(k) for that year.

If you are already making the maximum contribution to your 401(k), and can afford to increase this, making catch-up contributions can save you a significant amount of money in tax. However, the majority of workers simply do no earn enough to be able to contribute $27,000 a year to their retirement portfolio, and just 15% of 401(k) participants take advantage of catch-up contributions.

Articles You May Like

Is Alibaba Crazy for Buying into Groupon?
Top Wall Street analysts say buy these stocks during a market downturn
3 Stocks to Buy to Benefit from a Looming Energy Crisis
7 Retail Stocks That Will Win the Holiday Season
The Time to Buy INTC Stock Is Now