Should I Utilize Catch-Up Retirement Contributions?

While investment returns aren’t guaranteed, maxing out your retirement accounts each year can give you a good chance of amassing enough funds to comfortably retire someday. Once you reach the age of 50, you’ll be able to make catch-up contributions to increase your retirement savings.

Catch-up contributions increase the amount you’re able to invest each year so you can make up for the years when you may not have contributed enough to retirement. Only 39% of U.S. workers start saving for retirement in their 20s which means almost half of all Americans are getting off to a later start. However, you may be wondering if 50 years old is too late to make extra retirement contributions anyway. Will your money have enough time to grow and compound?

Here’s what you need to know about catch-up contributions in order to decide if it’s right for you.

What Are Catch-Up Contributions and How Do They Work?

The IRS allows you to start making catch-up contributions as long as you are 50-years-old or older by the end of the calendar year. Currently, you can contribute up to $19,500 per year to a 401(k), 403(b), 457(b), or TSA (Thrift Savings Plan). The catch-up contribution limit for these plans is currently $6,500 per year. This means you can contribute up to $26,000 per year to your 401(k) with catch-up contributions.

If you have an IRA, you can contribute up to $6,000 each year and $1,000 extra if you qualify to make catch-up contributions. With a SIMPLE 401(k) and a SIMPLE IRA you can contribute up to $13,500 each year and $3,000 each with catch-up contributions.

These extra contributions should be made by the due date of your tax returns (not including extensions) in order to count for the year. Most times, these extra deposits are deducted directly from your paycheck if you’re an employee and it’s called elective deferral contributions. After-tax contributions can also be made on your own timing during the tax year if you have an IRA.

Are Catch-Up Contributions Worth It?

On the surface, catch-up contributions sound like a good idea, but will it really be worth it to accelerate your retirement savings after you turn 50? Most financial advice out there encourages people to start investing early to take full advantage of compound interest.

If you’re wondering if an extra $1,000 per year will make a difference in the grand scheme of things, you may be asking the wrong question. It’s true that you can’t turn back time and recover the market growth you missed out on.

However, you should focus on narrowing down your retirement goals by determining what your desired target date is and what lifestyle you plan to have. Also, consider the retirement account(s) you have in place.

While the catch-up contribution for an IRA is low, you can also take full advantage of the 401(k) catch-up contribution or the SIMPLE IRA contribution if you have those accounts.

If you’re 50 years old and plan to retire at 67, that means you still have 17 years to grow your retirement balance and catch-up contributions could make a big difference. Not to mention, you can lower your taxable income, even more, when you contribute more to your employer-sponsored retirement plan.

Catching Up and Utilizing the Rule of 72

Say you’re planning to retire at 60 and you already have a sizable nest egg at 50. You already max out your 401(k) but take advantage of catch-up contributions and save an additional $260,000. Plus, you reduce your taxable income by $26,000 during each of those years.

That’s not all you’ll have invested though. The rule of 72 can help you estimate how many years it will take for your investment to double. The rule of 72 is just 72 divided by the estimated annual compounded rate of return. If you expect an average return of 8%, this means your money could potentially double in 9 years (72/8). This could give you over half a million dollars added to your retirement account (not even counting a potential employer match) during those 10 years of making catch-up contributions.

How to Make Catch-Up Contributions

If you want to start making catch-up contributions, the first thing you need to do is see if you can afford to make them. Most workers are not maxing out their retirement accounts each year, let alone making catch-up contributions.

Whether your aim is to contribute $7,000, $16,500, or $26,000 per year, you’ll have to budget for this increase. Consider cutting some of your existing expenses to free up more cash flow that can be invested. Bring your lunch to work and you could save at least $1,000 per year. Pay off your car loan to avoid the average car note of $400 per month. This will save you $4,800 per year. Consider using credit card rewards to help you save $1,000 to $2,000 to use toward  vacationing and trips. You can also downsize your home and save the difference from any raises you earn over time.

Once you’ve freed up room to make catch-up contributions, talk to your employer to confirm the extra deduction from your paycheck. If you’re contributing to an IRA, keep track of the catch-up contribution limit for that year and make sure your age is updated so you can make those extra deposits to your retirement account with no problem.

Changes in Limits

Realize that retirement contribution limits change each year due to factors like inflation and an increase in the cost of living. This means the odds are high that the catch-up contribution limit you have when you’re 50-years-old will be higher in future years.

While you always have the option to increase your contributions even more, realize that you don’t have to max out your retirement account or take advantage of the full catch-up limit if you can’t afford it one year.

Making extra retirement contributions once you turn 50 is completely up to you so you’ll want to consider your goals, budget, and make realistic projections. Talk to a financial professional or use an online retirement account growth tool to determine how catch-up contributions could positively impact your portfolio.