Still Time to Catch Up on Savings

If you are nearing retirement and have fallen short of your savings goal, it is not too late to play catch-up with your finances. The federal government allows people to make additional contributions in their later years.

A 2020 survey by Vanguard found that 98% of employers offer catch-up contributions on their 401(k) plans but only 15% of eligible employees take advantage. According to a recent Bankrate survey, 55% of Americans said their retirement savings are falling short, with nearly 35% indicating that they are significantly behind and another 20% reporting that they are somewhat behind on their financial goals.

Most investors can benefit from maximizing their savings during their working years, even as retirement approaches. For example, if your IRA earns a 6% average annual return, and you make an annual catch-up contribution of $1,000 starting in the year you turn 50, these catch-ups could generate more than $11,000 in investment earnings by the time you reach age 65. That would give you an extra $27,000 in retirement income.

Catch-up contributions to an IRA or 401(k) also yield another benefit. They lower your taxable income in the year you contribute. Because your taxable income is lower, you may be eligible for more deductions than what you had at the higher income level.

Catch-Up Contributions

The IRS allows individuals who are 50 or older by the end of the calendar year to make extra contributions beyond the standard limits. IRAs, employer-sponsored plans, SIMPLE IRAs, SIMPLE 401(k) plans, and even health savings accounts (HSAs) offer catch-up contributions. IRA contribution limits are annually adjusted for inflation.

IRAs, Traditional and Roth: For tax year 2025, you can make a $1,000 catch-up contribution—in addition to the $7,000 annual contribution limit—if you are age 50 or older, for a maximum of $8,000. Note that you can’t contribute more than you earn in any given year. You can make an IRA contribution for a given tax year anytime between January 1 of that year and the tax-filing deadline in the following year (usually April 15). Under the SECURE Act 2.0, future catch-up contribution amounts will be indexed to inflation.

401(k), 403(b):For tax year 2025, the maximum contribution limit for these retirement plans is $23,500, with a $7,500 catch-up contribution allowed for those who are 50 and over, for a total of $31,000. The SECURE Act of 2022 (SECURE 2.0) allows those who are ages 60 to 63 to make an even higher catch-up contribution for 2025—$11,250 instead of $7,500. These plan participants could potentially contribute $34,750 per year.

Beginning in 2026, though, savers over the age of 50 will be divided into two groups based on annual income:

• Those making $145,000 or less in the prior year can continue making catch-up contributions to their regular pre-tax 401(k)s.
• Those making more than $145,000 in the prior year will have to put their catch-up dollars in a Roth 401(k) which means those contributions will be after-tax, though their qualified withdrawals in retirement will be tax-free.

Health Savings Accounts (HSAs):In addition to traditional retirement savings, health savings accounts (HSAs) also have catch-up provisions. An HSA allows participants in high-deductible health insurance plans to save money for medical expenses while offering unique retirement savings benefits. Unlike flexible spending accounts, HSAs provide tax-advantaged investment opportunities that can be an additional retirement savings vehicle. If you can pay for health care expenses out of pocket rather than through your HSA savings, you can invest your HSA savings in a brokerage account, potentially growing your retirement nest egg.

The IRS sets annual contribution limits for HSAs: $4,300 for individual plans and $8,550 for family plans for 2025. HSAs offer catch-up contributions for individuals 55 and older, allowing them to save an additional $1,000 each tax year for future health care and retirement expenses.

When to Catch Up?

You might want to prioritize a catch-up contribution if one or more of these situations apply to you:

• Missed Investment Opportunities: If you’ve had gaps in your ability to add to your retirement savings during your working years, catch-up contributions are an excellent way to compensate for lost time and potential investment growth.
• Tax Strategies: If you have a high income and want to reduce your current tax liability, traditional IRA catch-up contributions may give you a valuable tax deduction. If you expect your current income to be higher soon, a Roth IRA catch-up contribution can provide tax-exempt income during retirement, when your tax rate might be higher.
• Budgeting: If it fits within your budget, a catch-up contribution can be an attractive option that can help you reach or exceed your retirement savings target.

When to Hold Off

You might want to hold off if these situations apply to you:

• Savings Goals: You have other savings goals, such as saving for a loved one’s education, taking a vacation, or buying a home, and you want to focus on saving for those plans. Also, you feel confident in your ability to reach or exceed your retirement goal.
• Currently taking withdrawals from a retirement account or you are ready to start.

Conclusion: Catch as Catch Can

Making (or skipping) a catch-up contribution in any given year won’t make or break your retirement dream. Catch-ups are simply an opportunity to save more as retirement approaches, if it fits into your budget and supports your goals.

If you’re on the fence about what to do, consider making a partial catch-up contribution, or make a catch-up contribution in just your IRA (but no other retirement accounts). You can also partner with a financial advisor who can give you a recommendation about catch-up contributions as part of your complete retirement plan.

As always, if you have any questions about this report or any other questions, please reach out to Bowen Asset at  info@bowenasset.com or (610) 793-1001.