Feel like you’re behind on saving for retirement? If so, you’re not alone. Retirement is a sizable financial challenge for millions of Americans. Fortunately, if you recently turned 50, you can take advantage of catch-up contributions, a powerful savings tool for those who are approaching retirement. It’s an extra amount that the IRS allows you to contribute to your qualified accounts above and beyond the normal thresholds.
Catch-up contributions are so effective because they help you add money to qualified, tax-deferred accounts, such as your 401(k) and IRA. You don’t pay taxes on growth as long as your funds stay inside the account. That tax deferral may help your assets grow at a faster rate than they would in a taxable account.
Catch-up contributions may also help you reduce your taxes today. As you may know, contributions to a traditional IRA are tax-deductible, assuming you meet income limits. Contributions to your 401(k) are deducted from your paycheck on a pretax basis. That means the contributions reduce your taxable income, which in turn reduces your tax exposure.
Want to use catch-up contributions to boost your savings? That could be a wise strategy. Below are a few tips to help you get started:
What is the catch-up limit for a 401(k) plan?
In 2018 you can make a standard contribution to a 401(k) plan of up to $18,500. This is a $500 increase from the limit in 2017. Once you turn age 50, however, you’re allowed to contribute an additional $6,000 as a catch-up contribution. This brings your total allowable contribution to $24,500.1
To take advantage of this strategy, you must be in a plan that allows catch-up contributions. Most plans do allow catch-ups, but there are some that don’t because of restrictions on highly compensated employees or other rules. Your company’s benefits department should be able to tell you whether catch-up contributions are permissible.
What are the catch-up limits for IRAs?
Are you one of the millions of Americans using an IRA to save for retirement? You can make catch-up contributions to your IRA in addition to your 401(k) plan. The standard IRA contribution limit for IRAs in 2018 is $5,500. If you’re age 50 or older, however, you can contribute an additional $1,000, bringing your total permitted contribution to $6,500.2
Catch-up contributions are allowed in either traditional or Roth IRAs. However, they’re subject to the same income rules as regular contributions. If you can’t contribute to a Roth or make tax-deductible contributions to a traditional IRA because your income is too high, you also won’t be able to take advantage of catch-up contributions.
How do you start making catch-up contributions?
Ready to start making catch-up contributions? You may want to begin by creating a budget and developing a plan for how you will save the extra money. For most people, a $24,500 contribution to a 401(k) is a big chunk of annual income. You may need to cut expenses in other areas to save that kind of money.
Your company’s human resources department can help you increase your contribution. You likely just need to fill out a form. The same is true with your IRA custodian. A financial professional can help you implement a catch-up strategy and show you how it will improve your financial stability in retirement.
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