If you're age 50 or older, you’re probably not boosting your retirement savings as much as you could.
Research indicates that few people are taking advantage of “catch-up” contributions, which allows fifty-somethings to contribute more than the standard limit to their 401(k)s and IRAs and boost their nest eggs. A study by mutual-fund company Vanguard’s Center for Retirement found that only 13 percent of the eligible participants made catch-up contributions in 2004. Another study by the Investment Company Institute (ICI) in Washington D.C., offered slightly better news: Only one-third of households with a person over age 50 made an IRA contribution in 2004, but out of that group, 47 percent made catch-up contributions.
But there is hope for those wanting to catch up on their catch-up contributions: You still have a few weeks to make an IRA contribution for tax year 2005. If you act before April 17, you can put in $4,000 (or $4,500 for those 50 and older) to your account.
For 2006, the 401(k) contribution limit is $15,000 participants younger than age 50, but those age 50 or older may contribute an additional $5,000 for a total of $20,000. For Roth IRAs and traditional IRAs, the annual contribution limit is $4,000, but fifty-somethings can put in an extra $1,000 for a total of $5,000.
Lack of funds and financial expertise
It's easy to see why most people don't take advantage of maximizing their retirement funds — they may not be able to financially. “That’s a lot of money to save,” said Stephen Utkus, a principal at the Vanguard Center for Retirement and an author of the study. “If you earn $75,000 and you’re already contributing 10 percent to your 401k for $7,500, that’s still well below the current threshold.”
And with so many changes in the tax laws, often on an annual basis, many people may not even be aware of the catch-up allowance, said Ed Slott, a certified public accountant and author of Parlay Your IRA into a Family Fortune. “Most people only hear of the $4,000 contribution limit because many financial institutions and advisors don’t bother to ask them if they’re over age 50. And if they’re not asked, people don’t know that they should ask.”
Those contributing on a regular basis to their retirement plan may not have to worry so much, said Utkus. “But based on the typical American’s savings rate, most of us should be taking advantage of saving in general.”
So who needs to take advantage of catch-ups? Utkus suggests a simple measurement. If you’re 50 years old and have savings equal to one year’s salary or less, then you definitely should maximize your contributions to the fullest. If you have twice your annual retirement in savings, you should still contribute but you may not need to worry as much about maxing out. If you have four times or more your annual salary, you’re in good shape.
Utkus says another group who should take advantage are those earning salaries in the six-figures. “Contributions are a great tax benefit for you, and you’ll have more savings in the bank since you won’t be able to rely on Social Security.”
But many high-income earners who are subject to limited 401(k) contributions may think they’re not eligible. Not so, said Jim Meigs, president of 401khelpcenter.com. “They may think that they have to contribute $15,000 before they can make a catch-up, but they only need to consider if they max out their company’s limit — that becomes the trigger point. So if your company’s plan has a catch-up provision and you mistakenly contribute beyond its limit, you can have the excess converted to your catch-up amount.”
You may want to max out on catch-up opportunities while you have the chance: The provisions are part of the Tax Relief Act of 2001, and unless Congress extends or makes them permanent, the act will sunset at the end of 2010, less than four year away. If Congress fails to act, contribution and catch-up limits revert to pre-2001 levels, plus inflation.
That means 401(k) limits drop to $14,000 and catch-up contributions disappear for everyone. And IRA contribution limits will go back to $2,000, which is too low of an amount to be effective for anyone’s retirement savings, said Sarah Holden, senior economist of retirement and tax research at the ICI. Her study shows that if catch-ups expire in 2010, the average 40 year-old worker who contributed the max to his IRA account annually would only have $171,000 in retirement accounts in 2031, when that person turns 65. If the catch-ups stay in place, that person's IRA will have $304,000, or nearly double.
“The limits now allow workers to put away a good amount,” said Holden. “And catch-ups are important for older workers because they have fewer years to save. If catch-ups sunset, the losses will cut across all age and income levels.”
But Utkus believes the catch-up contributions may be here to stay. “Despite all the concern over taxes and fiscal policy, bipartisan interest in savings policy will stay high, no matter what party is in charge.”
Sunset or no sunset, Ed Slott believes there’s no use in wondering. “No one knows what’s going to happen in the future, especially with politics. But take advantage of the provision while it’s available, and make the most of the opportunity to save more.”