Behind in Saving for Retirement? Catch-Up Contributions Can Be a Lifesaver

Clock March 08, 2023

BLOG >

30-second summary

Most Americans haven’t saved enough money in their retirement plan to live as comfortably as they’d like to when they retire.

Fortunately, older workers can make additional “catch-up contributions” to their retirement plans and accelerate their savings rate for retirement.

In this article, we’ll delve into:

  • What catch-up contributions are
  • How much more you are allowed to contribute
  • Catch-up contribution requirements
  • And more

We’ll also answer the question of whether it’s worth it to make catch-up contributions.

Lighthouse Life provides this article for informational purposes only and does not provide financial planning or investment advice. If you have questions about your assets, please contact a financial professional.

What are catch-up contributions?

Catch-up contributions are a way for workers aged 50 years and older to put more money into their tax-qualified retirement plans (401(k), 403(b), IRA) than workers 49 and younger.

Catch-up contributions became a provision under the tax law in 2001, which allowed older workers to set aside more of their earnings for retirement. It had become apparent that many retirees had inadequate retirement savings and were heavily dependent upon their Social Security income, which was not enough to maintain their pre-retirement standard of living.

Since then, the situation has not improved substantially. It’s estimated that in 2023, workers aged 50 and above have a retirement account balance of just over $325,000, which for most workers is far below the 8x multiple of salary that many personal finance experts recommend.

For example, a worker earning $60,000 in 2023 needs around $480,000 in their retirement account when they call it quits, which is about 33% more than the average worker has saved at retirement.

Withdrawing 7% of the average retirement fund annually, the maximum most advisors recommend, will yield about $1,500 per month after taxes. Unfortunately, this is not enough for many retirees.

Catch-up contributions are designed to help you increase your retirement account contributions as you age. Many people over 50 are now empty-nesters without the expense of raising children or paying for college, and in some cases, they no longer have a mortgage balance.

This allows them to set aside more money for retirement, which reduces their dependency on Social Security.

How much more can you contribute to your retirement plan in 2023 using catch-up contributions?

The IRS announced in October 2022 that the amount individuals could contribute in 2023 to their 401(k), 403(b), and most 457 plans has increased from $20,500 to $22,500.

The catch-up contribution in 2023 with these plans for individuals over 50 increased to $7,500, up from $6,500. The IRA contribution catch-up remains at $1,000.

This means that the maximum amount a worker 50 or older can contribute to their 401(k) in 2023 is $30,000, which is 25% more than their younger counterparts.

What are the catch-up contribution requirements?

The primary eligibility requirement for catch-up contributions is an individual’s age. Plan participants 50 or older at the end of the calendar year are eligible to make these additional contributions.

Some company-sponsored plans may also have specific eligibility requirements for increasing retirement plan contributions written into their plan document.

For example, employees who have been with the company for at least ten years may be eligible to make additional contributions to a 403(b) plan in addition to regular catch-up contributions based on age up to specified IRS limits.

Are catch-up contributions worth it?

In a word – yes (at least in most cases).

Many people think their living expenses will decrease during retirement. While that’s partially true, other factors, like inflation, must be considered.

Fidelity Investments estimates that if you know what your annual income is today, you can plan on spending 80% of that amount every year during your retirement. For example, if your pre-retirement income is $70,000, plan on spending $56,000 annually in retirement.

But don’t forget about a major nemesis of everyone, including retirees: inflation.

In the past 12 months alone (from March 2022 to February 2023), inflation has eroded your purchasing power by over 7%. While this has been an unusually high rate, you can still expect inflation to eat away 2-3% of your purchasing power every year.

While Social Security has cost-of-living adjustments (COLAs) to help recipients cope with inflation, your 401(k) or IRA doesn’t. With an individual retirement plan, you’ll either need to lower your expenses or increase your withdrawals as the years go by, which could result in exhausting your retirement savings before you die.

Catch-up contributions can help you increase your retirement savings and live the lifestyle you want when you reach the “finish line” at work. By putting more aside for retirement when you hit 50, you’re more likely to let your age determine when you retire, not your income.

 

Average rating 5 / 5. Vote count: 1

No votes so far! Be the first to rate this post.