Beth Pinsker: New catch-up contribution limits could boost your 401(k) — if you can afford them

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Older retirement savers eager to stuff as much as possible into their accounts will benefit from the omnibus spending bill that’s expected to make it through Congress this week.

But there are quite a few caveats when it comes to the new rules for catch-up contributions, which are the extra amounts the IRS allows you to save in an IRA or 401(k) if you’re 50 or over.

Saving for retirement has always been complicated, with lots of new rules to get used to. The grab bag of provisions of the so-called Secure 2.0 bill that are included in the omnibus takes that to a whole different level. There’s a little bit for everyone, from emergency savings to college to retirement.

Catch-up contributions might be the most complicated of them all. You’re probably going to need a flow chart to figure out how much you’re allowed to save, such as the one drawn up by Sean Mullaney, a financial planner and certified public accountant (CPA) based in Woodland Hills, Calif.

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If you’re 50-plus now, your choices are pretty simple. There’s one age and amounts that don’t usually change much year-to-year. The catch-up contribution for IRAs has been stuck since 2006 at $1,000, which can be added to a traditional or Roth IRA contribution of $6,500 in 2023. For 401(k)s, catch-ups are set to be $7,500 in 2023, on top of $22,500 that workers can put away, for a total of $30,000. 

But when the new catch-up contribution limits start in 2025, there will be one set of rules for those 50 to 59, another set for those 60 to 63 and still another set for those 64 and older. The dollar amount allowed for that age group 60 to 63 is a formula based on the base amount for catch-ups and would amount to $11,250 at today’s rates, for maximum contribution of $33,750 (but likely more in the future).

The amounts not only depend upon your age, but also your income level. If you earn more than $145,000, your catch-up deferrals need to go into a Roth 401(k) option, so this will only pertain to those who have that option in their workplace plan. 

The math on the max

One major hitch that holds up those currently 50-plus is that not many people hit the maximum amount you can contribute to a 401(k) and don’t get anywhere close to taking advantage of catch-up contributions. So currently, it’s mostly high-earners who contribute the full amount that they can. 

Vanguard has found that only 16% of those currently eligible for catch-up contributions save the extra amount. Only 14% hit the maximum 401(k) amount altogether. The number of people who can contribute in the future beyond what’s already available will likely be even smaller.

A study from the Center for Retirement Research at Boston College shows that past increases in the catch-up amount did not spur increases in retirement savings. “Since few participants — only about 10% — are constrained by the limits, raising them does not offer a broad-based solution for low saving rates,” the study concludes. 

The math is pretty clear if you look at salaries. If you’re 60 and make $75,000, saving the full $33,750 contribution would be 45% of what you make in a year. You’d have to make $225,000 for that amount to be 15%, which is the target amount many experts say you should put away for retirement. The median household income in the U.S. was $70,784 in 2021, according to the U.S. Census Bureau, and less than 10% make more than $200,000. 

Simplifying the solutions

One way to cut through the noise about the rule changes coming is to concentrate on your savings and let the IRS and the tax professionals sort out the rest over the next year. Saving for retirement really just comes down to consistently putting money aside — as much as you can, to the best of your ability — and keeping at it. It doesn’t have to be more complicated than that. 

Going forward from 2025, catch-up contributions will be indexed for inflation, so expect those numbers to rise considerably. That might end up being the most important part of the legislation, because, as we’ve seen for 2023 adjustments of all kinds, inflation can have a huge impact on government formulas. If you’re younger than 50, the amount you can contribute to retirement by the time you are older will be significantly higher than it would have been without that change. 

That could make a powerful combination with the auto-enrollment and auto-escalation provisions included in the omnibus changes. Those provisions will enroll new employees automatically in 401(k) plans at a rate from 3% to 10% and then increase that by 1 percentage point each year, unless the employee opts out.

That gives hope that millennials and Gen Z have a fighting chance to save enough for retirement, for sure, and maybe they’ll be in a position to make use of catch-up contributions by then. And if today’s older generations get the hint and also start increasing their contributions as much as they can, they can take the best advantage once the new catch-up rules come into effect.

Got a question about the mechanics of investing, how it fits into your overall financial plan and what strategies can help you make the most out of your money? You can write me at beth.pinsker@marketwatch.com

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