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How to Take Advantage of 401(k) Catch-Up Contributions

US News & World Report -  Money logo US News & World Report - Money 12/6/2021 Emily Brandon
Retirement funds aren't what they used to be © (Getty Images) Retirement funds aren't what they used to be

When you turn 50, you become eligible to contribute more money to your 401(k) plan. The tax deduction you can claim on these catch-up contributions could save you over $1,000 on your annual tax bill. Here's how to take advantage of 401(k) catch-up contributions:

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

Workers can defer paying income tax on as much as $20,500 that they contribute to a 401(k), 403(b) and the federal government's Thrift Savings Plan in 2022. Once you turn 50, you become eligible to make additional catch-up contributions of up to $6,500 to your 401(k) plan, for a total of $27,000 you can temporarily shield from income tax.

"The additional $6,500 permits employees who may be a little behind in saving for retirement to catch up a bit," says Robert Falcon, a certified financial planner for Falcon Wealth Managers in Concordville, Pennsylvania.

The 401(k) Catch-Up Contribution Age

Catch-up contributions allow workers age 50 and older to save more for retirement in a 401(k) plan. You can make catch-up contributions at any time during the calendar year in which you will turn 50, even if you have not yet reached your 50th birthday.

"If you are contributing a percentage of income to your retirement plan each month, it's important to be sure that the percentage is sufficient to meet the new maximum, including any catch-up contributions," says Danielle Seurkamp, a certified financial planner for Well Spent Wealth Planning in Cincinnati. "If you turn 50 next year, your contribution limit will go up $6,500 and you'll likely need to make an adjustment to be sure you start saving as much as possible."

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

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The tax advantage of making catch-up contributions can be huge. If a worker over 50 who is in the 35% tax bracket contributes the full $27,000 to a 401(k), he will reduce his current tax bill by $9,450, an extra $2,275 in tax savings.

A worker in the 24% tax bracket who contributes the same amount would save $6,480 in taxes, $1,560 more than younger workers. Income tax won't be due on the money in your 401(k) plan until it is withdrawn from the account. And if you drop into a lower tax bracket in retirement, you will pay that lower rate on 401(k) distributions.

Making catch-up contributions can significantly improve your 401(k) account balance in the years leading up to retirement.

"A modest 6% annual return assumption from age 50 to a typical retirement age of 65 could potentially result in approximately $140,000 more of savings beginning at retirement," says Shawn Ballinger, a certified financial planner and founder of Columbus Street Financial Planning in Dublin, Ohio. "Assuming a 25-year retirement, that $140,000 could potentially grow to approximately $600,000 during retirement. Making the catch-up contributions can make all the difference in living a more comfortable retirement."

How to Make Catch-Up Contributions

Most baby boomers (62%) say they are aware of their ability to make catch-up contributions to a 401(k) plan, but fewer than half of younger people know about this enhanced saving opportunity, according to a 2020 Transamerica Center for Retirement Studies online survey of 5,277 workers at for-profit companies.

In 2022, making a catch-up contribution means you contribute between $20,500 and $27,000 to your 401(k) plan at age 50 or older. Most 401(k) contributions are deductions from employee paychecks. To take full advantage of a 401(k) plan, a worker age 50 or older would need to contribute $2,250 per month, or $1,125 per twice-monthly paycheck.

Many older workers find it difficult to save $27,000 in a 401(k) plan. A worker earning $100,000 would have to save over a quarter of her pay to take full advantage of catch-up contributions. And someone earning $50,000 would need to tuck over half of his income into a 401(k) to get the maximum possible tax break.

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 found.

Roth 401(k) Catch-Up Contributions

Catch-up contributions can also be made to Roth 401(k)s. While you don't get an immediate tax break on the money you contribute to a Roth 401(k), you won't have to pay income tax on the investment growth in the account and can set yourself up for tax-free withdrawals in retirement.

"Unlike a regular 401(k) contribution, contributions to a Roth 401(k) are not made on a pretax basis, so the employee pays tax on $6,500 first, then contributes the extra $6,500 into the 401(k)," Falcon says. "The good news here is that the employee will never have to pay income taxes on the $6,500 nor on any appreciation that occurs on the $6,500 after it is contributed into the Roth 401(k)."

Copyright 2021 U.S. News & World Report


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