Can You Actually Catch Up With Catch-Up Retirement Contributions?

It's a story that's all too familiar to many: You spent most of your money in your younger days on buying a home, raising children, and saving for their college education. Now you're over 50 and you realized you're nowhere near ready for retirement.

Fortunately, the government enables adults 50 and over to contribute extra to their 401(k)s and IRAs to give them a better chance at a comfortable retirement. You're allowed to contribute up to $6,500 to your IRA in 2018, compared with just $5,500 for those under age 50. There are higher contribution limits with 401(k)s, with an $18,500 maximum for those under 50 and a $24,500 limit for those 50 and over.

But even those who are making catch-up contributions are often anxious about their retirement. After all, everyone knows that getting an early start on retirement savings is the key to building up a comfortable nest egg. While there is truth to this, catch-up contributions can go a long way toward closing the gap between where you are and where you want to be.

A catch-up contribution example

Ideally, you will have saved some money for retirement, however little, before you reach age 50. But for the purpose of this example, let's take the worst-case scenario and say that you don't have any retirement savings at all.

Say you're 50 years old and you plan on retiring at 67. That gives you 17 years to save before you need to begin drawing on that money. If you contributed the under-50 maximum 401(k) amount of $18,500 each year from now until your retirement, that would add up to $314,500. But that doesn't factor in compound interest. Assuming that your contributions have an 8% rate of return, that money will grow into $669,932 by the time you're ready to retire.

That amount could get even higher if your employer matches your contributions. For example, if there's a 3% match, your final balance when you're ready to retire would be $778,796. That may or may not be enough for you to retire on, depending on how long you plan on living and what kind of lifestyle you plan on having in retirement.

Now let's say you contribute up to the maximum $24,500 per year. Assuming all other factors are the same, you would have $887,208 without an employer match or $996,134 with a 3% employer match. That difference of an extra $6,000 per year adds up to a difference of over $200,000 for your retirement savings. That amount alone could comfortably sustain you for several years.

Is it enough to see you through your whole retirement? No one can say for sure. It's impossible to predict how long you're going to live, what tax rates and inflation are going to do, or what kind of unexpected health expenses could arise. But you can come up with a ballpark number. Try to estimate how long you plan on living and what tax bracket you expect to be in when you retire. For most people, it will probably be somewhere around 15%. Then, you also have to factor in inflation. Three percent per year is a good estimate. Use this information to estimate how much money you will need to see you through the end of your life and compare this to your current retirement savings.

What if my catch-up contributions aren't enough?

If you do the math and find out that even with catch-up contributions you're still behind where you want to be, there are additional steps you can take. Open an IRA if you don't have one already and contribute as much as you can up to the limit.

If you have extra cash left over, consider investing this in a non-retirement account. Unlike retirement savings, any money you put into a traditional investment account will be taxed when you earn it and when you withdraw it, but this is still a viable option for growing your money. If you're not confident in your own abilities to invest, consider hiring a financial advisor to assist you.

What if I can't afford to make catch-up contributions?

The worst-case scenario is not having any retirement savings and not being able to contribute very much to your retirement now. There may not be many good options, but there are still things you can do to give yourself a chance at a nice retirement.

First, contribute as much as you can as early as you can. The sooner you put money into your retirement accounts, the more compound interest can make it grow. If your employer offers a 401(k) match, this is where your money should go first so you can take advantage of that free cash. Otherwise, an IRA may be a better fit for you because the fees are usually lower.

You should also calculate how much money you'll need in retirement and then play around with the numbers to see what you can do. You may be able to get by on less if you delay your retirement by a couple of years or if you delay taking Social Security benefits until you're older. You may also consider working part-time in retirement or cutting back on your expenses so that you don't need as much money to live on.

Catch-up contributions can make a big difference in your retirement savings, especially if you start making them as soon as you're eligible to do so. Remember that contribution limits change periodically, so keep an eye out for opportunities to put even more money toward your retirement.

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