What Are Catch-up Contributions & How Do They Work?

Sometimes people aren’t able to allocate as much money to retirement savings as they’d like, especially early in their career when they might have imminent financial needs and aren’t making as much money as they might later on. According to a recent Vanguard report, only 12% of participants in 401(k) plans contribute the $19,500 limit, and 27% of participants contribute less than 4% of their annual income to their 401(k).

To help bridge the gap between what they may not have saved early on in life, catch-up contributions allow people to contribute extra as they near retirement.

What is a catch-up contribution?

Retirement savings accounts

, like employer-sponsored 401(k)s, have annual contribution limits. A catch-up contribution is a contribution to a retirement savings plan that exceeds the annual limit. To be eligible to make a catch-up contribution, investors must be age 50 or older. They can start making catch-up contributions in the calendar year they turn 50, even if it’s before their 50th birthday.

Catch-up contributions were introduced in The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001. At that time, the provision was set to expire in 2010, but the Pension Protection Act (PPA) of 2006 made catch-up contributions and other pension-related rules, like increased salary deferral contribution limits to a 401(k), permanent.

Catch-up contribution limits

Catch-up contributions are available for a few different types of retirement savings accounts, but the catch-up limit and the overall limit are different depending on the kind of account. Retirement accounts that allow for catch-up contributions include the commonly used employer-sponsored 401(k), traditional IRAs, Roth IRAs, and Simplified Employee Pension (SEP) IRAs. Here’s a closer look at contribution limits for various types of retirement accounts.

401(k)

In this employer-sponsored plan, employees make contributions to their 401(k) with pretax income. Taxes are paid on this money when it’s withdrawn during retirement.

As of 2022, the annual limit for a 401(k) plan is $20,500, but workers 50 and up can make an annual catch-up contribution of $6,500, bringing the overall limit to $27,000. Some employers choose to match their employers’ contribution up to a certain percentage. Employer contributions do not count toward the maximum 401(k) limit.

IRAs

Similar to 401(k)s, traditional individual retirement accounts, or IRAs, are funded with pretax income, and tax isn’t due until the money is withdrawn. Unlike a 401(k), an IRA does not have to be sponsored by an employer.

With a Roth IRA, contributions are made with post-tax dollars, but they’re not taxed when they’re withdrawn for retirement.

Both traditional and Roth IRAs have an annual contribution limit of $6,000, but those aged 50 and older can make an annual catch-up contribution of $1,000, bringing the overall limit to $7,000.

Traditional IRA and Roth IRA account holders can only contribute a combined $6,000, plus the $1,000 catch-up contribution, to both accounts. If they also have a 401(k) plan, it will not affect their IRA contribution limit (though it can affect tax deductions).

SEP IRA

A SEP IRA is similar to a traditional IRA in that it is not tied to an employer, so it’s commonly used by self-employed workers or owners of small businesses. Like 401(k)s and traditional IRAs, contributions are made with pretax income and taxed once they’re withdrawn during retirement.

Unlike a traditional IRA, a SEP IRA has a higher annual contribution limit of $13,500. Those aged 50 and older can make an annual catch-up contribution of $3,000, bringing the overall limit to $16,500.

While they have high contribution limits, there are other eligibility requirements and stipulations involved with SEP IRAs—meaning they’re not for everyone.

How to calculate your maximum catch-up contribution

To begin making catch-up contributions, investors can set their contribution rate to meet the higher limit—say, $26,000 versus $19,500 for a 401(k)—by the end of the year.

Because 401(k) contributions are made as a percentage of gross income, and lump sum contributions may not be allowed, it takes a little math to figure out how to meet, but not exceed, the annual contribution limit.

To max out their 401(k), a 50-year-old employee would contribute $26,000 over the course of the year. If they make $100,000 per year, they need to set their contribution rate to 26%. If they make $150,000 per year, their contribution rate will be 17%. To simplify the calculation (and ensure meeting the maximum contribution), it helps to set the contribution rate at the beginning of the year, so it can stay consistent.

Contribution rate needed to reach >50 Limit = (($19,500 + $6,500) / Annual salary) x 100

If people do accidentally make deposits that go beyond the annual contribution limit, they will need to withdraw the extra money before they do their taxes. Otherwise, they’ll be subject to a 6% excise tax on the amount that exceeds the limit.

The bottom line

Saving for retirement can be intimidating, and most people don’t (or are unable to) set aside enough money early in their career. Catch-up contributions are a tool for people aged 50 and older to step up their savings as they near retirement.‍