Benefits of a 401(k)
A pre-tax 401(k) offers several benefits for employees saving for retirement. Key highlights include:
- Tax advantages: Contributions are made on a pre-tax basis, which means you can reduce your taxable income for the calendar year. Withdrawals during retirement are taxed as ordinary income.
- Employer matches: Many employers match a portion of their employees’ contributions up to a certain percentage of their total compensation, providing additional funds for retirement savings.
- High annual contribution limits: For 2023, the IRS sets a limit of $22,500 for an employee’s annual contributions to employer-sponsored retirement plans. This limit allows retirement savers the chance to build a substantial nest egg over time.
And again, it’s important to remember that 401(k) contributions are not after-tax. When it comes time to retire, you’ll need to pay income tax on your 401(k) distributions.
If you’re interested in making after-tax contributions to a retirement plan (so you’re not taxed when you eventually make withdrawals), consider an Individual Retirement Account (IRA) or a Roth 401(k), if your employer offers one.
Wondering what you can do with your old 401(k)? We’ve published an article on your options — or take a look at how Capitalize can help.
How Do Contribution “Catch-ups” Work?
Contribution catch-ups are additional contributions that employees aged 50 and older can make to their 401(k) accounts. This feature is designed to help older savers take advantage of their 401(k) plans and make up for lost time by making available extra contributions to their retirement accounts.
For 2023, the annual contribution limit for employee contributions to a 401(k) is $22,500. However, employees aged 50 and older can contribute an extra $7,500, bringing their total annual contribution limit to $30,000. This allows them to save more pre-tax money and potentially lower their tax bill in the year of contribution.
Not all workers age 50 years or older take advantage of catch-up contributions, but if they can, it’s usually recommended that they should. In a recent survey conducted by GOBankingRates, it was reported that nearly 80% of Americans have less than $50,000 saved for retirement.
That said, the perception of retirement is changing rapidly — especially among young people. Capitalize conducted its own survey to learn more about how younger workers are planning save for their golden years.
Benefits of Catch-up Contributions
If you’re a worker approaching age 50 and thinking about shoring up your personal finances, it may be time to consider catch-up contributions. 401(k) catch-ups offer several benefits for eligible savers:
- Catch-up contributions, like normal employee contributions, are made pre-tax; this means they can reduce your taxable income for the year, and hopefully, your tax bill.
- You become automatically eligible for contribution catch-ups when you reach age 50.
- Contributions can be made to a Roth 401(k) for potential tax-free withdrawals in retirement.
- Catch-up contributions provide a valuable savings option for those who start saving for retirement later in life.
- Some employers may match catch-up contributions, providing even more retirement savings potential.
- A small catch-up contribution is also available for IRAs (traditional or Roth IRA) to the tune of $1,000 per year if you’re over 50. Note that this is in addition to the normal IRA contribution limit of $6,500 in 2023.
You might be wondering what the differences between a traditional 401(k) and a Roth 401(k) might be. We’ve got you covered.
Why You Should Consider 401(k) Contribution Catch-ups
Employees 50 and over should consider catch-up contributions — and, when they can, hitting their catch-up contribution limit — for several reasons:
- Additional catch-up contributions can further reduce your tax bill, especially for those in higher tax brackets.
- Catch-up contributions can help maximize your retirement savings and take advantage of tax-free withdrawals (if your employer offers a Roth 401(k)).
- Utilizing catch-up contributions can provide a valuable tax break and help diversify your investment portfolio.
Did you know that most retirement savers are in the dark about their 401(k) plan contributions?
Whether you’re making small deferments, the maximum contribution, or even actively trading within your 401(k) brokerage account, experts recommend setting attainable retirement goals for your savings accounts.
The Bottom Line
Catch-up contributions are an excellent way for eligible employees to boost their retirement savings, reduce their tax bill, and make up for any lost time in building their nest egg.
By understanding how catch-up contributions work and taking advantage of them, you can ensure a more secure retirement.
A rollover specialist — like Capitalize — can help you navigate the complexities of retirement savings to help you optimize your strategy.
Reach out today to discover how we can help you make the most of your retirement savings.
