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Retirement accounts such as IRAs and 401(k)s allow older account owners to make additional contributions each year, known as catch-up contributions. The idea is to allow people who are getting close to retirement age to add more to their nest egg in the years leading up to leaving the workforce — especially if they aren’t on track for a comfortable retirement and need to “catch up.”
Recent legislation known as the Secure Act 2.0 made a major change to the catch-up contribution rules for higher earners. Specifically, the legislation said that catch-up contributions to employer retirement accounts like 401(k)s must be deposited in Roth accounts, thereby eliminating the additional tax break (traditional 401(k) contributions are tax-deductible).
Originally, the new rule was set to go into effect starting in 2024. However, the IRS recently announced that the change would be delayed by two years, and now will go into effect in 2026.
Essentially, this means high earners can make additional tax-deductible (pretax) contributions for another two full years.
In employer-sponsored retirement plans like 401(k) and 403(b) accounts, the standard limit for employee deferrals in 2023 is $22,500. This is the amount participants can choose to defer from their paychecks — it doesn’t include things like employer matching contributions.
In addition, participants aged 50 or older can choose to contribute an additional $7,500, for a total contribution of $30,000 for 2023. If you have a 403(b) plan, there’s an additional catch-up contribution allowance for employees who have been with the same employer for at least 15 years.
Although the new rule won’t apply to individual retirement accounts, or IRAs, it’s important to mention they are eligible for catch-up contributions as well. The standard contribution limit to traditional or Roth IRAs in 2023 is $6,500, and account owners 50 or older can set aside an additional $1,000.
There are two financial considerations when it comes to catch-up contributions.
The more immediate is the tax benefits, and the amount you can save depends on your marginal tax rate (tax bracket). But just as an example, let’s say you’re in the 35% tax bracket. Making a $7,500 catch-up contribution to a 401(k) can save you $2,625 on your 2023 taxes. And thanks to the rule change delay, you can do the same in 2024 and 2025.
The longer-term consideration is the additional retirement nest egg potential. As an example, let’s say you turn 50 this year. You usually max out your 401(k) but this year you contribute an additional $7,500 as a catch-up contribution. Based on a 7% annualized average return, that catch-up contribution could result in an additional $20,700 in your 401(k) by the time you’re 65.
On the other hand, if you make a $7,500 catch-up contribution every year from the time you turn 50 until you’re 65, it could mean an extra $209,000 for your retirement. That could mean a big difference in your financial security.
There’s a solid case to be made that all retirement account owners who can afford to do so should take advantage of catch-up contributions. The near-term tax benefits can be substantial, and even if you don’t really need to catch up, there’s nothing wrong with giving yourself a bit more financial cushion after you retire.
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