Editor’s Note: This story originally appeared on NewRetirement.
Most of us are pretty stressed about the need to give our savings a big boost as we approach retirement. Guess what? There’s actually a relatively little-known retirement savings strategy that can really help: catch-up contributions.
Catch-up contributions are the way the IRS uses to allow savers age 50 and older to accumulate enough retirement savings.
You probably already know that there’s a limit to the amount you’re allowed to save in tax-advantaged retirement accounts like IRAs and 401(k). Well, once you reach age 50, you’re allowed to make additional “catch-up” contributions beyond those annual contribution limits.
However, according to a study by the Transamerica Center, only 52% of workers are aware of catch-up contributions. It’s time to learn more about this strategy and start applying it to your retirement planning — here’s what you need to know.
2022 contribution limits for retirement savings accounts
Contribution limits and the annual catch-up allowance vary depending on the type of retirement savings account you have. However, if you’re 50 or older and have both an IRA and a 401(k), you can save an additional $7,500.
For 2022, the catch-up contribution ceilings are as follows.
401(k) contribution catch-up
The annual 401(k) plan contribution limit is $20,500 while the catch-up contribution is $6,500.
This means that if you’re 50 or older, you can contribute a total of $27,000 per year to your 401(k). (Your total contribution, including employer matching funds, cannot exceed $61,000 – or $67,500 for workers age 50 and older.)
Catch-up contributions to the IRA
The annual IRA contribution limit is $6,000 and the IRA catch-up contribution is $1,000, allowing workers age 50 and older to contribute a total of $7,000 per year.
Note that the contribution limits for traditional IRAs and Roth IRAs overlap. In other words, if you’re 50 or older, you can contribute a total of $7,000 per year, split however you like between traditional and Roth IRAs (assuming you meet the income limits for contributing). a Roth account).
However, the boundaries between 401(k)s and IRAs do not not overlap, so you can maximize your contributions for both account types in the same year.
Why catch-up contributions are important
According to a GOBankingRates survey, 29% of adults 55 and older have no retirement savings and 15% have less than $10,000 saved.
However, don’t despair if you feel you don’t have enough. Catch-up contributions can make a real difference.
If you are falling behind on your retirement savings, capping your annual contribution and your catch-up contribution may be enough to fund a safe and reasonably comfortable retirement.
The potential value of catch-up contributions
Let’s say you just turned 50 and you have no retirement savings. However, turning 50 is a red flag for you, so you decide on the spot to maximize your retirement contributions to your 401(k) and Roth IRA.
For 2022, you could save a total of $26,500 per year in these two accounts without catch-up contributions. If you could save that much every year until you were 65 and earn an average return of 6% per year on that money, you would end up with about $617,000 after 15 years.
Now add to catch-up contributions, which give you an additional $7,500 per year for a total of $34,000 per year of retirement savings. At this rate of savings, you could accumulate close to $800,000 by age 65. That means an extra $7,500 a year that you can save through catch-up contributions translates to an extra $193,000 in your retirement savings accounts.
Are you married? Double those amounts!
How do you find the money to save as catch-up contributions
Of course, it’s easy to see how beneficial it is to save at least as much as the IRS recommends. However, finding the money to save can be the real challenge.
To save more for retirement, you don’t need to find new sources of income, you just need to rethink your existing expenses.
Explore “23 Big and Small Ways to Save More for Retirement”.
Now add the tax savings from the catch-up contributions
Catch-up contributions don’t just help you save more for your retirement; they also help you reduce your tax bill. When you save money in a traditional IRA or 401(k), you are not required to pay taxes on those contributions. This means you can save more money in these accounts without affecting the amount you have left for other expenses.
For example, let’s say you’re single and earn $200,000 a year. In 2017, you would have paid federal income taxes of $49,399.25 on that salary. But if you contributed $24,000 of that money to your 401(k) account, your taxable income for the year would be reduced to $176,000.
Therefore, you would only owe $42,261.75 in federal income tax. So contributing $24,000 to your retirement savings account saved you $7,137.50 in taxes. That’s over $7,000 that you now have to spend on other expenses. Without access to catch-up contributions, you could only have contributed $18,000 to that 401(k) and your tax savings would have been only $5,457.50.
Saving money in a Roth account also gives you tax relief, but in a different way. With Roth accounts, you don’t get a deduction on the money you put into the account, but when you take money out of the account, you don’t have to pay taxes on it. If your retirement income will be limited, being able to reduce your tax bill at that time can make a significant difference in your standard of living.
Reducing your taxable income in retirement can have more benefits than just stretching your retirement income a little further. For example, Social Security benefits become taxable if half of your Social Security benefits plus your other taxable income exceed certain limits. Since Roth IRA distributions are not taxable income, they do not count in this calculation. Therefore, putting your annual IRA contribution into a Roth account can result in an even better tax deal than putting that money in a traditional IRA.
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