Catch-up Retirement Contributions
“The best time to plant a tree was 20 years ago. The second-best time is today.”
This quote is relevant to many areas of life, but perhaps none more so than retirement planning. While many people feel they haven’t done enough or are too late to save for retirement, there are always steps that can be taken to set a foundation for the retirement phase of our lives.
It is always important to take advantage of retirement benefits offered through employers or on an individual basis, though there is a special emphasis placed as we enter the highest earning years of our careers and retirement becomes more than just a vague idea for a future date.
With that in mind, to help promote retirement savings, certain incentives are granted to individuals once they reach the age of 50. Both workplace-sponsored plans (think 401ks, 403bs, 457s and SIMPLE IRAs) and individual accounts (IRAs and Roth IRAs) are eligible for this provision.
The limits for each plan are as follows in 2023:
- 401k, 403b, 457, and TSP Plans: A Catch-up amount of $7,500 is added to the annual contribution limit of $22,500, bringing the total limit for anyone over 50 to $30,000.
- SIMPLE IRAs: A Catch-up amount of $3,500 is added to the annual contribution limit of $15,500, bringing the total limit for anyone over 50 to $19,000.
- Traditional and Roth IRAs: A Catch-up amount of $1,000 is added to the annual contribution limit of $6,500, bringing the total limit for anyone over 50 to $7,500.
SECURE 2.0 Changes
With the recent passage of the SECURE 2.0 Act in late 2022, some additional changes were made to Catch-up contributions. These impact both employer-sponsored plans as well as IRAs.
In SECURE 2.0 are accelerated Catch-up provisions for anyone age 60-63 participating in an employer-sponsored plan starting in 2025.
The accelerated provisions for anyone aged 60-63 are as follows in 2025:
- 401k, 403b, 457, and TSP Plans: A special Catch-up amount of $10,000/yr increases from the $7,500 referenced above.
- SIMPLE IRAs: A special Catch-up amount of $5,000 increases from the $3,500 referenced above.
These amounts will be indexed to inflation starting in 2026, after their first year of being in place.
Important to note: For those earning more than $145,000, the IRS will require catch-up contributions to be made on a Roth (post-tax) basis.
Catch-up contributions in workplace plans have very high thresholds. While many don’t have the ability to put away $30,000 a year into retirement accounts, these increased contributions apply to a much wider range of individuals in IRA plans. These provisions are a valuable tool as additional amounts can be contributed towards retirement while in your highest-earning years; the additional $1,000 represents savings for retirement in a tax-efficient manner, which will grow and can be utilized at a future time in retirement, in line with an overall financial plan tax strategy.
Traditional v Roth Contributions
Having mentioned both types of retirement contributions, it will be beneficial to do a deeper dive into each, and how they should be considered in terms of your financial picture.
In a nutshell, the decision between Traditional and Roth contributions into an employer-sponsored plan or an IRA can be summed up as: will you be paying a higher percentage of income tax now or in retirement? The Tax Cut and Jobs Act of 2017 made this a somewhat easier question, as income tax rates are currently at historically low levels and will remain there until 2026. This lowering of tax levels has shifted Roth contributions towards the spotlight as they have become an extremely tax-advantaged strategy.
Roth contributions are made with “after-tax” dollars, meaning you do not get a deduction from your Adjusted Gross Income for tax purposes when you make the contribution. When it comes to withdrawing the funds, no income taxes are owed because money being taken out has already been taxed.
Traditional contributions, on the other hand, are made with “pre-tax” dollars, which gives you an Adjusted Gross Income deduction, thereby reducing total taxable income in the current year. In retirement, when the money is withdrawn, income tax will be paid at the prevailing rates during those years.
If you are in a position where you are earning more money now and, as a result, paying more in income taxes than can be expected in retirement, you’ll probably want to look at making “pre-tax” contributions in the current year. This will allow you to defer the income to later years in retirement when you can expect to be paying less as taxable income will be lower when not working a full-time job.
For many people who are not in their peak earning years, the 2017 tax law changes have made Roth contributions a more attractive option. Paying lower rates of taxes on money contributed in current years and then withdrawing the original amount saved (along with gains) without paying taxes will mean avoiding income taxes in those years of retirement. Not having gains reduced by income taxes is a satisfying bonus to look forward to with Roth accounts!
We think of Roth and Traditional accounts as separate retirement “buckets”; having funds in different taxable “buckets” gives great flexibility to funding retirement in a tax-efficient manner.
While navigating the world of retirement planning is initially daunting, an understanding of the updated benefits found in SECURE 2.0 helps to set the best financial foundation as retirement approaches. We are staying on top of the latest legislative developments to ensure our clients are taking advantage of all opportunities available to them in the retirement sphere.