Retirement Catch-up Contributions

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.