Retirement Account Catch-up Contributions Can Really Add Up

Tax law changes made back in 2001 established the right to make additional catch-up contributions to certain types of tax-advantaged retirement accounts. For 2010, this opportunity may be available to you if you will be age 50 or older as of year-end.

Specifically, you can potentially make additional salary reduction catch-up contributions to a 401(k) plan, 403(b) plan, 457 plan, or SIMPLE plan (assuming you participate in a plan that allows catch-up contributions). These contributions reduce your taxable income and therefore result in lower income tax bills. You can also make catch-up contributions to a traditional IRA (which may or may not be deductible depending on your circumstances) and to a Roth IRA. (Roth IRA contributions are always nondeductible, but they can be a good idea if you expect higher future tax rates.)

These catch-up contributions are above and beyond the “normal” annual contribution limits that otherwise apply to your tax-advantaged retirement accounts. The maximum allowable catch-up contribution for 2010 is $5,500 for 401(k), 403(b), and 457 plans. It is $2,500 for SIMPLE plans and $1,000 for traditional and Roth IRAs. However, depending on your salary level and the terms of your salary reduction plan, maximum allowed catch-up contributions to the plan could be less than the amounts shown here.

How much are the catch-up contributions worth? The beneficial long-term impact of making catch-up contributions is illustrated below. Remember, allowable catch-up contributions are now much bigger than back in 2002 when first allowed. For example, the maximum catch-up contribution to a 401(k) account for 2002 was only $1,000 versus $5,500 for 2010. The maximum catch-up contribution to a traditional or Roth IRA for 2002 was only $500 versus $1,000 for 2010. Therefore, you should now give catch-up contributions more respect than you might have earlier.

The following analysis proves the point.

Assume you turn 50 during 2010 and make the maximum catch-up contribution for this year and then do the same for the following 15 years, up to age 65. Here’s approximately how much extra you could accumulate by that age in the various types of retirement accounts, assuming the indicated annual rates of return:

Type of Account	Annual Catch-up Contribution	4% Rate of Return	6% Rate of Return	8% Rate of Return
401(k), 403(b), or 457 plan	$5,500	$120,000	$141,000	$167,000
SIMPLE Plan	2,500	55,000	64,000	76,000
Traditional or Roth IRA	1,000	22,000	26,000	30,000

The numbers prove that taking advantage of the opportunity to make additional annual catch-up contributions is not a trivial exercise. If your spouse can also make catch-up contributions, so much the better. Of course, the favorable impact is somewhat less than illustrated if you turned 50 before this year, but it is generally still a good idea. On the other hand, if you are disciplined enough to also save and invest the annual tax savings resulting from salary reduction contributions and any deductible IRA contributions, the dollars accumulated from making catch-up contributions could be even more than illustrated.