How Do 401(k) Catch-Up Contributions Work?

If your employer offers a 401(k) plan, this can be a very effective way of saving for retirement. The money that you put in your plan is tax deferred, so you won’t pay income tax on it for the year when you earn it. Instead, you’ll be taxed when you take it out of your 401(k) account during retirement. Since most people are in a lower tax bracket in retirement than they are when they are working, this can save you a lot of money. 

There are annual limits on how much you can contribute to your 401(k) account. In 2022, the limit was $20,500, increasing to $22,500 in 2023. However, people ages 50 and older can make additional catch-up contributions. Making these catch-up contributions can make all the difference when it comes to retiring comfortably. In this article, we’ll explain how you can make them and why you should.

Understanding Catch-Up Contributions

There are annual limits to how much you can contribute to your 401(k). In 2022, for people under 50 years old, this limit is $20,500, increasing to $22,500 in 2023. This limit applies across all 401(k) plans you have, including any Roth 401(k) accounts. It includes all elective employee salary deferrals and any after-tax contributions made to a designated Roth account within your 401(k) or a special Roth 401(k) plan.

The same contribution limits apply to 403(b) plans and most 457 plans, as well as to the federal government’s Thrift Savings Plan (TSP). However, contributions that you make to any other type of retirement plan, such as a traditional or Roth individual retirement account (IRA), don’t count toward the limit.

The only exception to this is once you reach 50 years old. At this point, to encourage workers nearing retirement to speed up their savings, the Internal Revenue Service (IRS) allows 401(k) participants ages 50 and older to make additional contributions beyond the standard contribution limit. If you are 50 or older, you can make an additional 401(k) contribution of $6,500 a year. This additional contribution increases to $7,500 in 2023.

This is known as a catch-up contribution, and it applies from the start of the year to those turning 50 at any time during the year. So, even if you turn 50 on New Year’s Eve, you can still make this extra contribution for that tax year.

Why You Should Make Catch-Up Contributions

There are a number of advantages to making catch-up contributions, and these are largely similar to the more general advantages of a 401(k) plan. By choosing to contribute more to your 401(k), you will further reduce your tax bill. If you are in a relatively high tax bracket, these savings can be significant: If a worker age 50 or older who is in the 35% tax bracket contributes the full $27,000 (for 2022) to a 401(k), they will reduce their current tax bill by $9,450, an extra $2,275 in tax savings compared with not making catch-up contributions.

In addition, if you start putting extra money into your 401(k) at age 50 and don’t retire until you are 65 or even older, it can boost the value of your retirement portfolio significantly. You’ll have saved almost an extra $100,000 in those 15 years, and that could grow still further during retirement, depending on the performance of the economy and how your money is invested.

That said, contributing $27,000 a year to a 401(k) is a stretch for many people. Even a worker earning a relatively generous salary of $100,000 per year would have to put aside a quarter of their income, and someone earning $50,000 a year is unlikely to be able to put aside half of their income for retirement. 

That is confirmed by the data. Almost all 401(k) plans (98%) permit catch-up contributions, but only 16% of participants take advantage of them when they are offered, according to an analysis of Vanguard 401(k) plans. It is primarily workers with high incomes and large account balances who are able to make catch-up contributions, Vanguard has found.

In other words, if you are already earning a good salary, are on track with your other financial goals, and are bumping up against the 401(k) contribution limit, catch-up contributions can be great. The majority of workers, however, are simply not earning enough to take advantage of the increased limit.

The Bottom Line

Workers ages 50 and older have a higher annual 401(k) contribution limit than their younger peers. In 2022, this catch-up contribution is $6,500 ($7,500 in 2023), meaning that those 50 and older can contribute a maximum of $27,000 to their 401(k) for that year ($30,000 in 2023).

If you already make the maximum contribution to your 401(k) and can afford to increase this, making catch-up contributions can save you a significant amount of money in tax. However, the majority of workers simply do not earn enough to be able to contribute $27,000 or $30,000 a year to their retirement portfolio, and just 16% of 401(k) participants take advantage of catch-up contributions.