Among the aphorisms attributed to Ben Franklin, one is especially apropos on retirement: “You may delay, but time will not.”
Many future retirees find that as the fateful day approaches, they wish they had saved more, particularly if their available vehicle is a defined contribution plan like a 401(k). While starting early is the best and most powerful way to assure a sufficient nest egg, it is often difficult to sock away the maximum allowable contribution during the early years of employment.
By the time a worker reaches maximum earning years, some of the force of compounding has been surrendered to the march of time.
For this reason, the tax code allows many retirement plan participants age 50 or older to supplement their annual salary deferrals with extra “catch-up” contributions to help make up the deficit from prior years.
These additional deferrals are not subject to the employer matching contribution (if any) and may not be allowed by a particular employer’s specific plan. If permitted, catch-up deferrals are not subject to non-discrimination testing for highly compensated employees.
For 2011, employees of any age enrolled in 401(k) plans may defer a maximum of $16,500 of pre-tax income (subject to plan limits). In addition, participants in plans that allow the catch-up bump may contribute an additional $5,500 provided they are age 50 or older. This legal limit applies as well to most 403(b) and 457 plans typically sponsored by not-for-profit and governmental employers.
Simple IRA and Simple 401(k) plans allow a $2,500 catch-up deferral, while traditional and Roth IRA accounts provide for a $1,000 extra contribution for the 50-and-over set.
Consider an employee in the 25 percent marginal tax bracket. When he turns 50, the maximum supplemental deferral of $5,500 invested yearly subject to an annual return of 6 percent would provide an additional $128,000 in retirement savings by 65.
Furthermore, since the contributions are pre-tax, the participant defers $1,375 in federal income tax each year or $20,625 over the 15-year period.
Note that the tax code provides for catch-up contributions but does not mandate that an employer’s plan allow for them. Be sure to check with your company’s administrator to determine whether your plan accepts supplemental deferrals. If not, request that your employer consider adopting an amendment to permit them.
Christopher A. Hopkins in a chartered financial analyst and vice president of investments for Barnett & Co. Inc.