November 13, 2017

Boost retirement savings and reduce taxes with Catch-Up contributions

Making Catch-Up contributions from age 50 until retirement can add up to significantly more money in retirement.
Dawn Doebler, MBA, CPA, CFP®, CDFA®, Senior Wealth Advisor

One of the benefits of turning 50, besides getting your AARP card, is the ability to super charge your retirement savings. For those in the 50-and-older age group, the catch-up contribution allows you to save even more through your retirement plan at work or in an IRA.

The catch-up contribution is a way to save another $6,000 (2017 limit) in a company-sponsored 401k plan, 403b or the federal government's Thrift Savings Plan on top of the regular deferral limit of $18,000.  If you're self-employed, retirement plans like a solo 401k also allow catch-up contributions of $6,000. By taking advantage of the catch-up, you can increase your annual contributions by 33 percent!  For traditional or Roth IRAs, the 2017 catch-up contribution amount is $1,000 over the base contribution of $5,500.

Those extra savings add up to more money in retirement

Making these extra tax-advantaged contributions can have a significant impact on your retirement nest egg. Fidelity estimates that by saving the maximum $6,000 catch-up in a 401k plan starting at age 50 until retirement, you can add an additional $1,000 per month of income during your retirement.  Another study shows that if you contribute an extra $1,000 per year from age 50 and for the next 20 years, with an average rate of return of 7 percent, you could add nearly $44,000 more towards your retirement.

Even if you can't contribute the full amount of the catch-up, saving $1,000 or $2,000 more each year can really add up. This handy Catch-Up Calculator will give you an idea of just how much more you could have in retirement.

Catch-up contributions reduce your taxes

Putting away these extra savings will help to reduce your 2017 taxes too. If you're in the 35 percent tax bracket and contribute the full $18,000 to your 401k, plus another $6,000 in catch up contributions, you may be able to reduce your federal income tax bill by a total of $8,400. The catch-up portion accounts for $2,100 of that tax savings. In this case, making a $6,000 catch-up contribution actually impacts your disposable income by just $3,900.

This can be a good time in life to redirect any extra savings you might have to your retirement. For instance, many 50 somethings with kids in college may be nearing the end of tuition payments or other contributions they have made toward their children’s education. While it may be tempting to spend those extra dollars, the better decision is to maximize your retirement contributions while you still can. 

For other retirement planning tips, read: Reset your retirement reality: what to do now that you are 50.

Most are missing out on this savings and tax opportunity

Many people are either unaware of, or are not taking full advantage of plan contribution limits or additional savings from the catch-up provision.  A 2014 Government Accountability office report showed that only 3 percent of 401k participants age 50 and over contribute the maximum possible to their plan.  Fidelity reports that only 8 percent of their customers were making use of the $6,000 catch up contribution. 

As you may expect, those with higher incomes are more likely to take advantage of the catch-up. Even so, Vanguard found that those over 50 making more than $100,000 per year utilize the catch-up only 42 percent of the time.  That's still less than half of those eligible for the savings incentive. This is a missed opportunity that can amount to a more secure retirement. 

There’s still time to make catch-up contributions for 2017

Time is running out for 2017, so if you want to take advantage of the catch-up, you'll need to act soon. 

  • ‍First, confirm if your plan allows catch-up contributions. While almost all plans (about 97 percent) do have this provision, you'll need to be sure they are permitted in your specific plan.
  • Next, find out how much you have contributed so far this year to your retirement plan. You can usually find this on your pay stub, or you can contact your plan administrator to confirm year-to-date contributions and expected contributions until year end.  If you will reach the $18,000 maximum deferral, then consider making catch up contributions.
  • Finally, ask your retirement plan or human resources administrator to change your elections to withhold the additional amount between now and December 31st.

Keep in mind that you can contribute only up to your total earned income, so if you earn less than $24,000, your contributions will be capped at your total earnings.  If you want to make the $1,000 additional catch up contribution to a regular or Roth IRA, you have a bit more time to act. These contributions can be made up until your tax filing deadline for 2017 which is April 17, 2018. 

Plan now to contribute more next year

If you can’t take advantage of a catch-up this year, consider doing so in 2018. Next year the opportunity is even greater with the maximum retirement plan contribution amount increasing to $18,500. The catch-up remains the same at 6,000 for a total contribution potential of $24,500. There’s no change to the IRA catch-up which stays the same at $1,000 in 2018.  If you’re approaching age 50, be sure to contact your HR or plan administrator as they may not automatically inform you of the catch-up opportunity.

Reducing income taxes and increasing retirement savings are universal goals, and even more compelling for those in their 50's.  Taking advantage of the maximum allowable retirement plan contributions is an easy way to accomplish both goals.  When you factor in the immediate tax savings, contributing to a catch-up is more attainable—and more valuable—than many people realize.

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Shawn: Now you hear all kinds of deals about leasing cars, how can you negotiate a better deal if you want to lease?

Nina: Okay, well many people don't realize that they can actually negotiate the sticker price on a leased car in the same way that you would do that if you're buying a car. And since when you lease -- when you're, you know, your lease payments basically cover the depreciation, the difference between the sales price and the residual value. So it's definitely in your best interest to try to reduce that sales price as much as possible because then you'll pay you know, smaller dollars over the life of the lease. Make sure you pay attention to the down payment at the lease signing. And so here's an example, you might see an ad that says you know, lease payment is only 1.99 a month and that sounds like a great deal for thirty six months. The catch is, is that it might require a $3,600 down payment. So, if you amortize the down payment, then actually that 1.99 special, becomes 2.99. So, you really have to kind of look at total costs. 

And then lastly, dealerships use the term, money or lease factor, when they're calculating your financing costs and a lease factor is not the same as an interest rate. So, you have to make sure the dealer converts that lease factor into a comparable interest rate so you know what your financing charges are. 

Shawn: At the end of the day, does one method wind up being more expensive more often than the other, or can we tell that?

Nina: You know what, it really depends on how long, if you're going to hold the car for a long time, you're better off buying. But if you know, and if you're not, if you just really enjoy driving and you want to have a new car, then go ahead and lease. I mean, there's pros and cons to both, to be honest with you, it's not one size fits all.

Shawn: Alright Nina, great. Happy Thanksgiving to you. Alright, Nina Mitchell is with The Colony Group, for more go to wtop.com and search Her Wealth.

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Dawn Doebler, MBA, CPA, CFP®, CDFA®, Senior Wealth Advisor

Dawn’s experience spans more that 25 years providing wealth management, financial planning and corporate finance solutions for clients. As an MBA, CPA, Certified Financial Planner (CFP®), and a Certified Divorce Financial Analyst (CDFA®), she is uniquely qualified to understand the challenges and financial needs of clients from executives to entrepreneurs, as well as single breadwinner parents. Dawn is a weekly contributor to WTOP radio.