Fill Your IRA & 401(k) to the Brim

Some people say that 50 is the new 30. Living longer and healthier lives might make you feel young if you are 50, but your retirement account begs to differ. Anyone who’s turning 50 or older on or before Dec. 31 is allowed to make retirement catch-up contributions starting that year. Catch-up contributions can yield big tax savings, so let’s look at how they work and some ways you can take advantage of the rules.

401(k) plans limit people younger than 50 to a maximum contribution of $18,000 per year on a pre-tax basis. Catch-up contributions work by allowing those 50 and older to stash away extra money in a 401(k) or IRA – as much as an additional $6,000 per year pre-tax. This means that someone 50 or older can save up to $24,000 per year in their 401(k), all of it shielded from taxes. Note that the catch-up provision isn’t limited to 401(k) plans. It also applies to 403(b) accounts for nonprofit employees, 457 plans for government workers, and for self-employed solo 401(k) plans.

Solo 401(k) plans for self-employed persons have the same limits as regular 401(k) plans, but they also have the added benefit of allowing the owners to save part of their profits pre-tax in their retirement plan. Businesses can make a profit sharing contribution of up to 25 percent (only 20 percent for sole proprietors and single member LLCs), creating the potential for a total deferral of up to $60,000 ($18,000 401(k) contribution + $6,000 catch-up + $36,000 in profit sharing).

Keep in mind that in order to put $36,000 away in profit sharing, your business would have to make $144,000 in profit per owner, but obviously there is huge potential here. With $60,000 tax deferred, assuming a 35 percent combined federal and state tax rate, this means you just kept $21,000 instead of giving it to the government. Now take that and compound market returns on it and watch your retirement plan grow.

You might be wondering about Roth 401(k) plans, the type of plan where your contributions are not tax deductible but your withdrawals are tax free. Roth 401(k) plans also allow the catch-up contribution so you can stash all or part of the $6,000 catch-up into this type of plan as an option.

The retirement plan catch-up provision is not limited to employer-sponsored plans; they also are available for Roth IRAs and traditional IRAs. The same age rules apply, but the amounts are different. Both Roth IRA and traditional IRA accounts have a catch-up limit of $1,000 per year. Various other less common retirement plans also have their own catch-up contribution limits. SIMPLE IRAs have a catch-up limit of $3,000, while SEP-IRAs have no catch-up provision. Don’t forget that IRA accounts have their own set of rules regarding eligibility, which are beyond the scope of this article.

Retirement plan catch-up provisions can help you reach your retirement goals and result in significant tax savings. Consult with your tax advisor to see if this strategy makes sense for your situation.

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