How Catch-Up Contributions Help You Reach Your Retirement Savings Goal

Investing as much as you can, as early as you can, is the ideal strategy when it comes to retirement savings. However, even the most diligent investors can find themselves falling short of their savings target as they approach retirement. You may have experienced a savings lapse along the way due to a job loss or time off to care for family, or your income needs in retirement may have increased. But there are steps you can take to improve your situation and get your savings on track. Catch-up contributions to tax-advantaged retirement plans are one step that can be beneficial if you are age 50 or older.

“Turning 50 is a major personal milestone for many people, and it’s also a good opportunity to reassess your progress toward your retirement goal,” says Roger Young, CFP^®, a thought leadership director with T. Rowe Price. “Catch-up contributions become a valuable tool for setting aside more money for retirement.”

T. Rowe Price recommends saving 15% of your annual income for retirement, including any employer match. One challenge can be the limits the IRS places on how much investors can contribute to any tax-advantaged accounts on an annual basis, however. In 2022, the 401(k) contribution limit is $20,500, while the individual retirement account (IRA) contribution limit is $6,000. Fortunately, 2022 catch-up contribution limits for investors 50 and over allow older individuals to invest more.

Catch-up contributions are a way to help investors save more in the years leading up to retirement. In 2022, those age 50 or older can contribute an additional $6,500 to their 401(k) plan each year, as well as an extra $1,000 across Traditional and Roth IRAs combined.

How do catch-up contributions work? The extra boost can help savers achieve their savings targets and allow high-income earners to allocate more of their savings to tax-advantaged accounts. People with high incomes may have found it difficult to achieve a 15% savings target in their workplace plans due to the standard contribution limits. The availability of catch-up contributions may make it easier to set aside more funds through payroll deductions.

Taking advantage of the annual catch-up contribution can make a significant difference over the years left to save before retirement. Consider two investors who each earn $150,000 a year. At age 49, Julie and Jim each have $600,000 saved in their 401(k)s. They currently save up to the 401(k) contribution limits set by the IRS each year through payroll deductions of $20,500, which represents just 13% of their salaries. When they both turn 50, however, only Julie takes advantage of 401(k) catch-up contributions, saving an additional $6,500 annually—as much as the 2022 401(k) catch-up limit allows. Jim continues to save at the standard limit.

By the time they both turn 65, Julie could have saved nearly an additional $175,000 for retirement, representing a 7.9% increase over Jim’s savings. (See The Catch-Up Effect.)

IRA catch-up contributions work in much the same way, providing a potential savings boost for investors with earned income who may not have access to a 401(k) plan. However, they wouldn’t be ideal options for Julie or Jim, as their income levels mean any contributions to a Traditional IRA would not be deductible. In addition, their income exceeds the 2022 Roth IRA contribution limit of $144,000 (for single filers). But for investors who can make a tax-deductible IRA contribution, saving an additional $1,000 each year can lead to an extra $25,100 saved in an IRA, simply by leveraging catch-up IRA contributions from age 50 through age 65.¹

“Finding extra money in your budget to save for retirement might be difficult,” says Young. “But the same principles that guided your savings plan early in your career still apply when you’re age 50 or older: Save as much as you can, as early as you can.”

First, ensure that you are making full use of 401(k) and IRA contribution limits to set aside 15% of your salary.

This target can be achieved through a combination of saving in a 401(k) and a Traditional or Roth IRA, as is appropriate. If needed, identify additional funds in your household budget that could be redirected toward retirement savings to reach those 2022 contribution limits and catch-up contribution limits.

If you have a spouse or partner, don’t forget to evaluate your retirement savings as a couple. If you are married filing jointly, but only one spouse is earning income, you might consider saving for retirement for the nonworking spouse through a spousal IRA to increase your maximum contribution as a couple.

Second, consider scheduling gradual increases to your contributions each year or earmark any new flexibility in your budget toward your retirement accounts. For instance, investors in their 50s may find that they have additional income available once they have achieved other savings goals, such as saving and paying for their children’s college or paying off their mortgage. They may also be entering their peak earning years, which could mean larger raises or bonuses. All of those offer opportunities to catch up on retirement savings.

If you’ve been maximizing your savings in your tax-advantaged accounts and you have supplemented that savings effort by setting aside money in a taxable account, consider reallocating some of those taxable savings to catch-up IRA or 401(k) contributions. “This decision will depend on your situation, including how much you’ve already saved, and the timing of your goals,” says Young. “If you have financial goals that will occur before retirement and already have saved a substantial amount in your tax-deferred accounts, then you might want to stay flexible with your savings plan by continuing to use your taxable accounts.”

Do catch-up contributions make a difference? That depends on the size of your savings gap and your ability to save more. Consider taking advantage of the ability to save more for your retirement by making catch-up contributions. Even if your savings plan is on track, the higher limits can also help you build additional savings in a Roth IRA account to add flexibility in your retirement income plan. Whether or not catch-up contributions make sense in your situation, the age-50 milestone can be an opportunity to evaluate your progress and celebrate your achievements.