What Are Catch-Up Contributions Really Worth?
What degree of difference could they make for you in retirement?
Provided by Jamie Hansman, Financial Advisor, Duxbury MA
At a certain age, you are allowed to boost your yearly retirement account contributions. For example, you can direct an extra $1,000 per year into a Roth or traditional IRA starting in the year you turn 50.1
Your initial reaction to that may be: “So what? What will an extra $1,000 a year in retirement savings really do for me?”
That reaction is understandable, but consider also that you can contribute an extra $6,000 a year to many workplace retirement plans starting at age 50. As you likely have both types of accounts, the opportunity to save and invest up to $7,000 a year more toward your retirement savings effort may elicit more enthusiasm.1,2
What could regular catch-up contributions from age 50-65 potentially do for you? They could result in an extra $1,000 a month in retirement income, according to the calculations of retirement plan giant Fidelity. To be specific, Fidelity says that an employee who contributes $24,000 instead of $18,000 annually to the typical employer-sponsored plan could see that kind of positive impact.2
To put it another way, how would you like an extra $50,000 or $100,000 in retirement savings? Making regular catch-up contributions might help you bolster your retirement funds by that much – or more. Plugging in some numbers provides a nice (albeit hypothetical) illustration.3
Even if you simply make $1,000 additional yearly contributions to a Roth or traditional IRA starting in the year you turn 50, those accumulated catch-ups will grow and compound to about $22,000 when you are 65 if the IRA yields just 4% annually. At an 8% annual return, you will be looking at about $30,000 extra for retirement. (Besides all this, a $1,000 catch-up contribution to a traditional IRA can also reduce your income tax bill by $1,000 for that year.)3
If you direct $24,000 a year rather than $18,000 a year into one of the common workplace retirement plans starting at age 50, the math works out like this: you end up with about $131,000 in 15 years at a 4% annual return, and $182,000 by age 65 at an 8% annual return.3
If your financial situation allows you to max out catch-up contributions for both types of accounts, the effect may be profound indeed. Fifteen years of regular, maximum catch-up contributions to both an IRA and a workplace retirement plan would generate $153,000 by age 65 at a 4% annual yield, and $212,000 at an 8% annual yield.3
The more you earn, the greater your capacity to “catch up.” This may not be fair, but it is true.
Fidelity says its overall catch-up contribution participation rate is just 8%. The average account balance of employees 50 and older making catch-ups was $417,000, compared to $157,000 for employees who refrained. Vanguard, another major provider of employer-sponsored retirement plans, finds that 42% of workers aged 50 and older who earn more than $100,000 per year make catch-up contributions to its plans, compared with 16% of workers on the whole within that demographic.2
Even if you are hard-pressed to make or max out the catch-up each year, you may have a spouse who is able to make catch-ups. Perhaps one of you can make a full catch-up contribution when the other cannot, or perhaps you can make partial catch-ups together. In either case, you are still taking advantage of the catch-up rules.
Catch-up contributions should not be dismissed. They can be crucial if you are just starting to save for retirement in middle age or need to rebuild retirement savings at mid-life. Consider making them; they may make a significant difference for your savings effort.
Jamie Hansman may be reached at (781) 934-5432 or firstname.lastname@example.org
Securities and Advisory Services offered through LPL Financial Member FINRA/SIPC
This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
1 - nasdaq.com/article/retirement-savings-basics-sign-up-for-ira-roth-or-401k-cm627195 [11/30/15]
2 - time.com/money/4175048/401k-catch-up-contributions/ [1/11/16]
3 - marketwatch.com/story/you-can-make-a-lot-of-money-with-retirement-account-catch-up-contributions-2016-03-21 [3/21/16]