How to catch up on retirement savings

FROM MARKETWATCH.COM

If you’re age 50 or older, you can make extra “catch-up” contributions to certain types of tax-favored retirement accounts. Many people fail to capitalize on this opportunity because they don’t realize that making these extra contributions can make a significant difference in their retirement-age wealth. Here’s the proof.

Catch-Up Contribution Basics

Assuming your company retirement plan allows them, you can make extra salary-reduction contributions to your 401(k), 403(b), or 457 account starting with the year you turn age 50. Salary reduction contributions are subtracted from your taxable wages, so you effectively get a federal income tax deduction for making them. If your state has a personal income tax, you’ll generally get a state tax deduction too. You can use the resulting tax savings to help pay for part of your catch-up contribution, or you can set them aside in a taxable retirement savings account to further increase your retirement-age wealth. Either way, it’s all good.

You can also make extra catch-up contributions to your traditional or Roth IRA. If you’re 50 or older as of Dec. 31, 2013, you can make a catch-up contribution for the 2013 tax year and you have until April 15, 2014, to get it done. Contributions to deductible IRAs create tax savings, but your income may be too high to qualify. Contributions to Roth IRAs don’t generate any up-front tax savings, but you can take tax-free withdrawals after age 59½ (assuming you’ve had at least one Roth account open for over five years). There are income restrictions on Roth contributions too. Worst case, you can make extra nondeductible traditional IRA contributions and benefit from the account’s tax-deferred earnings advantage. Remember: You have until April 15 to make IRA catch-up contributions for the 2013 tax year.

Maximum catch-up contributions for both the 2013 and 2014 tax years are as follows.

401(k), 403(b) and 457 Plans: $5,500

Traditional and Roth IRAs: $1,000

How Much Extra Could You Accumulate?

Quite a bit, because maximum catch-up contributions are considerably larger than when they were first introduced a few years ago. For example, in 2002 the maximum catch-up contribution to a 401(k) account was only $1,000 versus $5,500 now. The maximum catch-up contribution to a traditional or Roth IRA was only $500 versus $1,000 now. Let me give you some numbers to help quantify how much extra retirement-age wealth you could pile up by making catch-up contributions.

Impact of Salary Reduction Catch-Up Contributions

Say you turn 50 this year and contribute an extra $5,500 for 2013. Then you do the same for the following 15 years, through age 65. Here’s how much extra you could accumulate by age 65 in your 401(k), 403(b), or 457 plan (rounded to the nearest $1,000).

4% Annual Return: $120,000

6% Annual Return: $141,000

8% Annual Return: $167,000

Remember: Making larger contributions can also lower your tax bills

Once again, say you turn 50 during 2013 and contribute an extra $1,000 for this year and then do the same for the next 15 years, through age 65. Here’s how much extra you could accumulate in your IRA by age 65 (rounded to the nearest $1,000).

4% Annual Return: $22,000

6% Annual Return: $26,000

8% Annual Return: $30,000

Remember: Making larger deductible contributions to a traditional IRA can also lower your tax bills. Making additional contributions to a Roth IRA won’t, but you can make tax-free withdrawals later in life.

Impact of Salary Reduction Plus IRA Catch-Up Contributions

Finally, let’s say you turn 50 during 2013 and make an extra $5,500 salary reduction catch-up contribution for this year plus an extra $1,000 IRA contribution. Then you do the same for the following 15 years, through age 65. Here’s how much extra you could accumulate by age 65 in the two accounts together (rounded to the nearest $1,000).

4% Annual Return: $142,000

6% Annual Return: $167,000

8% Annual Return: $197,000

The Bottom Line

As you can see, extra catch-up contributions can potentially add up to some pretty big numbers by the time you reach retirement age. If your spouse is able to make catch-up contributions too, you can double all the amounts shown here. This is something to think about, especially if you have doubts about whether Social Security will be there for you when you need it.