Are You Taking Advantage of Catch-up Contributions on Your 401k?

The amount you can contribute to your 401(k) plan increases when you turn 50. With these catch-up contributions, you could save over $1,000 on your yearly tax bill. You can catch up on your 401(k) contributions by following these steps:

The 401(k) Catch-Up Contribution Limit for 2022

Workers who contribute to 401(k), 403(b), and the federal government’s Thrift Savings Plan in 2022 can defer paying income tax on up to $20,500. At 50, you may make additional catch-up contributions of up to $6,500 to your 401(k) plan, for a total of $27,000 you can temporarily deduct.

Robert Falcon, a certified financial planner for Falcon Wealth Managers in Concordville, Pennsylvania, says the additional $6,500 allows employees who may be behind in retirement savings to catch up.

The 401(k) Catch-Up Contribution Age

Catch-up contributions are allowed for employees over 50 in 401(k) plans. Even if you have not yet turned 50, you can make catch-up contributions during the calendar year in which you will turn 50.

You can still make catch-up contributions the year you turn 50; even if you haven’t yet reached your 50th birthday, you can contribute a percent of your income to your retirement plan each month.

You should contribute a certain percentage of your income to your retirement plan each month should be sufficient to cover the new maximum. This should include any catch-up contributions, says Danielle Seurkamp, a certified financial planner at Well Spent Wealth Planning in Cincinnati. When you turn 50 next year, your contribution limit will be increased to $6,500, so make sure you begin saving as soon as possible.

The Tax Benefit of a 401(k) Catch-Up Contribution

Making catch-up contributions can have a considerable tax benefit. In the case of a worker over 50 in the 35% tax bracket, contributing $27,000 to a 401(k) will reduce his current tax bill by $9,450, saving him an additional $2,275.

If workers in the 24% tax bracket contributed the same amount, they would save $6,480 in taxes, $1,560 more than younger workers. The money in your 401(k) plan won’t be taxed until you withdraw it. 401(k) distributions will also be taxed lower if you drop into a lower tax bracket in retirement.

You can significantly increase your 401(k) account balance by making catch-up contributions in the years leading up to retirement.

Shawn Ballinger, the founder of Columbus Street Financial Planning in Dublin, Ohio, says if you assume a modest 6% annual return from age 50 to 65, you will have approximately $140,000 more saved when you retire. “If you retire in 25 years, $140,000 could grow to approximately $600,000. Making catch-up contributions will make a big difference to your retirement.

How to Make Catch-Up Contributions

According to a 2020 Transamerica Center for Retirement Studies online survey of 5,277 workers at for-profit companies, 62% of baby boomers know about their ability to make catch-up contributions to 401(k) plans. However, fewer than half of young people are aware of this enhanced savings opportunity.

When you are 50 or older, you can make a catch-up contribution to your 401(k) plan between $20,500 and $27,000 in 2022. Most 401(k) contributions are deducted from employees’ paychecks. Workers age 50 and older would need to contribute $2,250 per month, or $1,125 per paycheck, to take advantage of 401(k) plans.

Many older workers find saving $27,000 in a 401(k) is difficult. To take full advantage of catch-up contributions, a worker earning $100,000 would have to save more than a quarter of her income. To get the maximum tax benefit, someone earning $50,000 would need to contribute over half of his income to a 401(k).

A Vanguard 401(k) plan analysis found that nearly all plans allow catch-up contributions (97%), but only 15% take advantage of them when offered. Vanguard found that catch-up contributions are made mainly by workers with high incomes and large accounts.

Roth 401(k) Catch-Up Contributions

Roth 401(k)s also allow catch-up contributions. Roth 401(k)s don’t offer an immediate tax break on contributions, but you won’t pay income tax on investment growth in the account and can withdraw tax-free in retirement.

Falcon says employees who contribute to Roth 401(k)s do not pay taxes on $6,500 before contributing $6,500 more. Employees will never have to pay income taxes on the $6,500 or any appreciation that occurs on the $6,500 after it is contributed into the Roth 401(k).