Make Extra “Catch-Up” Contributions to Retirement Accounts: We Quantify the Benefit

After reaching age 50, you can make additional “catch-up” contributions to certain types of tax-advantaged retirement accounts. For the 2021 tax year, this opportunity is available if you’ll be age 50 or older on Friday, December 31, 2021.

Specifically, with an employer-sponsored 401(k), 403(b), 457, or SIMPLE plan, you can make extra salary-reduction catch-up contributions to your account—assuming the plan allows catch-up contributions.

If you are self-employed and have set up a 401(k) plan or SIMPLE IRA for yourself, you can also make extra catchup contributions to your account.

Finally, you can make extra catch-up contributions to a traditional or Roth IRA.

These catch-up contributions can carry a hefty punch because they are above and beyond the “regular” annual contribution limits that otherwise apply.

The following table shows maximum allowable catch-up contributions for the 2021 tax year:

If you’re married and both you and your spouse are age 50 or older, the amounts shown above can potentially be doubled, assuming both spouses have accounts set up in their respective names.

But with an employer-sponsored plan, maximum salary-reduction catch-up contributions to your account might be less than the indicated amounts—depending on employee participation levels and the terms of the plan.

The Question: How Much Are Catch-Up Contributions Worth?

This is where it gets interesting. While some folks eagerly embrace any chance to contribute more money to tax advantaged retirement accounts, others might need some encouragement. Those in the latter category may dismiss catch-up contributions as inconsequential unless proven otherwise. Fair enough. We can prove otherwise, and we do so below.

Please understand that we are not going to cover all the technical rules that apply to retirement account contributions in general and catch-up contributions in particular. The purpose of this article is simply to illustrate the long-term impact of making extra catch-up contributions, so you can see the benefit and decide for yourself whether to take advantage.

The other important thing to understand here is that maximum catch-up contribution amounts are considerably larger now than they were back in the day. For example, the maximum catch-up contribution to a 401(k) account was only $1,000 for 2002 versus $6,500 for 2021. The maximum catch-up contribution to a traditional or Roth IRA was only $500 for 2002 versus $1,000 for 2021.

Maximum catch-up contributions for 2023 and beyond could be increased if inflation persists.

Now for proof of the benefits from making catch-up contributions. Here goes.

Proof: Make 401(k), 403(b), or 457 Plan Catch-Up Contributions

Assume you turn 50 during 2021 and contribute an extra $6,500 to your account for this year, and then you do the same for the subsequent 15 years (for a total of 16 years), up to age 65. Here’s how much extra you could accumulate by that age in your 401(k), 403(b), or 457 account (rounded to the nearest $1,000), assuming the annual rates of return indicated below:

These are substantial amounts. Of course, we are talking before-tax numbers here.

Proof: Make SIMPLE Plan Catch-Up Contributions

Say you turn 50 during 2021 and contribute an extra $3,000 for this year, and then you do the same for the subsequent 15 years (for a total of 16 years), up to age 65. Here’s how much extra you could accumulate by that age in your SIMPLE plan account (rounded to the nearest $1,000), assuming the annual rates of return indicated below:

Not bad! Once again, remember that these are before-tax numbers.

Proof: Make IRA Catch-Up Contributions

Say you turn 50 during 2021 and contribute an extra $1,000 for this year, and then you do the same for the subsequent 15 years (for a total of 16 years), up to age 65. Here’s how much extra you could accumulate by that age in your IRA (rounded off to the nearest $1,000), assuming the annual rates of return indicated below:

These are before-tax numbers for traditional IRAs but after-tax numbers for Roth IRAs.

Key point. The 2019 Setting Every Community Up for Retirement Enhancement (SECURE) Act removed the previous age limit on making annual traditional IRA contributions. Now you can continue to make annual contributions as long as you have earned income for the year that at least equals your contribution for that year.

Key point. There has never been any age limit on annual Roth IRA contributions. You can make annual contributions as long as you have earned income for the year that at least equals your contribution for that year.

Proof: Make Both 401(k), 403(b), or 457 Plan and IRA Catch-Up Contributions

Finally, let’s say that you turn 50 during 2021 and make an extra $6,500 catch-up contribution this year, and then you do the same for the subsequent 15 years (for a total of 16 years), up to age 65. You also contribute an extra $1,000 to your IRA for each of those years. So, you contribute a combined $7,500 extra each year. Here’s how much extra you could accumulate by that age in the combined accounts (rounded off to the nearest $1,000), assuming the annual rates of return indicated below:

Wow! Those are pretty big numbers! If your spouse can do the same thing, these amounts could potentially be doubled. Good grief, that’s good!

Takeaways

Running the numbers proves the case for making extra catch-up contributions to your retirement account(s).

If you are disciplined enough to also save and invest the annual tax savings resulting from your retirement account contributions, including any catch-up contributions, you could accumulate even more than what we have illustrated here.

While you won’t collect any current tax savings from making catch-up contributions to a Roth IRA, doing so is a sound financial strategy, in our opinion.

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