A recent survey found that 23% of people were very confident about having enough money to live comfortably through their retirement years, but 33% were not confident.2 That's a third of the population that is unsure whether or not they'll have enough money to last them throughout retirement.
To help remediate this issue, Congress passed a law that can help older workers make up for lost time with catch-up contributions. But few may understand how this generous offer can add up.3 Preparing for retirement just got a little more financial wiggle room. The Internal Revenue Service (IRS) announced new contribution limits for 2022. But, first, let's learn more about what catch-up contributions are and help you determine whether or not you're eligible.
What are Catch-Up Contributions?
Catch-up contributions allow workers over age 50 to make contributions to their qualified retirement plans in excess of the limits imposed on younger workers.
Contributions to a traditional 401(k) plan are limited to $19,500 in 2021, soon to change in 2022, when the limit will be $20,500.1,4 If permitted by the 401(k) plan, participants age 50 and over can also make catch-up contributions. You may contribute additional elective salary deferrals of $6,500 in 2021 to traditional and safe harbor 401(k) plans.
Setting aside an extra $6,500 each year into a tax-deferred retirement account has the potential to make a big difference in the eventual balance since these contributions are elective deferrals that exceed the regular limits. These limits may be imposed by the IRS and/or the plan itself.
Now that you understand what catch-up contributions are let’s look at the eligibility requirements to make these contributions.
Requirements for Catch-Up Contribution Eligibility
The main requirement of being a catch-up eligible participant is that you are at least 50 years old. But you may actually be able to take advantage of these contributions even before your birthday. The IRS states that “a participant is catch-up eligible with respect to a plan year if the participant turns age 50 by the end of the calendar year in which the plan year ends.”5
This means that even if your birthday is in July if your plan has a plan year of January–December, you may be deemed “age 50” in January and can therefore make catch-up contributions starting at the beginning of your plan year.
Another important aspect of catch-up contributions is the eligibility of your retirement plan. Catch-up contributions may be made to a 401(k) plan, a 403(b) plan, a governmental 457(b) plan, a SARSEP, a SIMPLE 401(k), or a SIMPLE IRA, but you should check the specific terms of your retirement plan to understand your catch-up contribution eligibility as plans can be set up differently.
A last note about catch-up contribution eligibility is that just because you are 50 years old or older doesn’t mean that you are eligible for catch-up contributions in the form of the regular $6,500 stated above. For example, your 401(k) plan might have its own elective deferrals, an employer match, and a profit-sharing contribution. As of 2021, the dollar limitation on annual additions according to the IRS is $55,000. If all of these contributions together add up to more than $55,000, that difference counts as your catch-up contributions if you are over 50, up to $6,500. Meaning you don’t then get an additional contribution.
2022 Contribution Limits
Staying put for 2022 are traditional Individual Retirement Accounts (IRAs), with the limit remaining at $6,000. The catch-up contribution for traditional IRAs remains $1,000 as well.1
For workplace retirement accounts such as a 401(k) or 403(b), the contribution limit rises by $1,000 to $20,500. Catch-up contributions remain at $6,500.1
Eligibility for Roth IRA contributions has increased, as well. These have bumped up to between $129,000 to $144,000 for single filers and heads of households and $204,000 to $214,000 for those filing jointly as married couples.1
Another increase was for Savings Incentive Match Plans for Employees (SIMPLE IRAs), which increases from $13,500 to $14,000.1
Once you reach age 72, you must begin taking required minimum distributions from a Traditional Individual Retirement Account (IRA) or Savings Incentive Match Plan for Employees IRA in most circumstances. Withdrawals from Traditional IRAs are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty.
Once you reach age 72, you must begin taking required minimum distributions from your 401(k), 403(b), or other defined-contribution plans in most circumstances. Withdrawals from your 401(k) or other defined-contribution plans are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty.
To qualify for the tax-free and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59½. Tax-free and penalty-free withdrawal can also be taken under certain other circumstances, such as the owner's death. The original Roth IRA owner is not required to take minimum annual withdrawals.
As you near retirement, it's crucial to understand how much you can (and should be) contributing to your retirement plan, as well as other tax and deferral implications. Working with a qualified financial advisor can be illuminating as you prepare for this important life milestone.
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