For many of us, retirement planning is a persistent boogie man in the back of our minds. The statistics on people’s lack of retirement preparation are staggering, and the official retirement age seems to increase by the minute. Life expectancy is getting longer, and resources seem to be getting scarcer. Any hand that savers and wage-earners play at this point in life seems like a bet against the house, sure to lose.
One of few aces up your sleeve, money hacks, or shortcuts that’s still available to you is the retirement catch-up contribution. This is a small extra amount that wage-earners can contribute annually to most retirement funds later in their career.
Most of us have been contributing to some kind of IRA since we started working, perhaps just out of college when we weren’t sure what those letters even meant! There’s a cottage industry of different ways these funds are structured, paid into, taxed, and moved around, and it’s often something we don’t give a second thought.
Today, let’s look at what it means to “catch up” a retirement fund, and how that can pay off for you in the long run.
Catch-Up Contributions – Four Types
The idea of retirement catch-up contributions first appeared in the Economic Growth and Tax Relief Reconciliation Act as part of the measures to combat the 2001 recession. The stipulation was supposed to phase out in 2011 but was made permanent by the Pension Protection Act of 2006. Now some kind of retirement catch-up contribution is part of life for all Americans for the foreseeable future, so there’s no reason not to take advantage of it.
Catch-up contributions are laid out carefully, of course, by the IRS, as are regular retirement contributions. The IRS wants to strictly regulate how many tax-qualified dollars it allows out in the world, so there are caps for catch-ups. Let’s look at a few of the most well-known.
Qualified Employer Plans
401(k), 403(b), 457, etc. – are all under the same rules. Catch-up starts at 50 years old and has a $6,000 cap.
Roth IRA and Traditional IRA
The IRS’s own plans have a $6,000 per year contribution limit. Starting at 50 years old, participants can catch up an extra $1,000 per year.
Simple IRA
The Simple IRA plan is for business owners themselves, so the rules are slightly different. The annual cap for contributions is $13,000 and the catch-up allowed is $3,000. Again, this starts at 50 years old.
Health Savings Account
Another retirement-related financial vehicle is the Health Savings Account, a tax-advantaged savings account that can be used for qualified medical expenses. Currently, an HSA has a contribution limit of $3,500 for one person or $7,000 for a family. In addition to this, at age 55 participants can start catch-up at $1,000 per year.
This is not an exhaustive list, but it covers the retirement-related finances most people participate in. Although the numbers may seem small from some angles, – such as only having 15 years or so to throw an extra grand in there – keep the math in mind. One-thousand dollars for 15 years at 5 percent return is $22,657, so starting at 50 years old and putting away an extra $83 a month can cover some large expenses in your retirement years.
Now’s the Age
You may have noticed the common denominator in most of these: 50 years old. This is an age when simple wage-earning has hopefully given way to healthy wealth building. The kids are grown and gone, or almost, the house and cars are paid off to a manageable level, and retirement has left the theoretical shelf in your mind.
You’re also at an age when medical expenses are at a reasonable level, and this is probably the last stretch of life where that’s true. You and your spouse, as well as kids who are over their childhood cuts and bruises, are at a place where the hospital bills aren’t quite as steep. This is a calm moment to start putting away a little extra for the future.
Now’s the Time
This topic makes sense for our midwinter newsletter because this is often the time those end-of-year bonuses and raises start actually appearing on paychecks. These pleasant discussions in recent months have now become dollars and cents, which should be invested wisely.
One important behavioral bias to be aware of when this cash appears is mental accounting. This behavior makes us treat certain money in certain ways, an emotional qualification we attach to the cash with no basis in reality. We tend to think of bonuses as windfalls and therefore might blow through the money – mental accounting at its worst.
In reality, this bonus or raise is earned income and should be treated like all other earned income – managed wisely for the security of you and your family. It’s your money, you deserve it! But you should treat it like an extra paycheck and not like a $20 bill you found on the sidewalk.
One small hack that’s helpful here is to leave your 401(k) contribution on when your larger paycheck comes through. Unfortunately, many people turn that contribution off and miss the chance to put a little extra away. Leaving it on will help start you in the right direction to then make a more substantial contribution.
Your Money, Your Future
At the end of the day, retirement contributions – catch-up or otherwise – are about paying yourself, which any financial advisor will tell you is a priority. Making sure your retirement is well-supported will lift some stress today and ease a future burden on your family. This is an investment whose sense can’t be argued.
Your financial advisor is a great sounding board for brainstorming ideas and running numbers. They can give you an idea of what your contributions look like in the long term and how contributing fits into your financial plan today.
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This piece is designed to provide accurate and authoritative information on the subjects covered. It is not, however, intended to provide specific legal, tax, or other professional advice. For specific professional assistance, the services of an appropriate professional should be sought.