Use the Catch-Up for 401(k) Investments

How catch-up investments can figure into your year-end planning

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Scott Holsopple

To ensure you’re covering your bases in 2011 and you’re well prepared for 2012, now is a good time to review your financial situation. Everyone could benefit from creating a year-end financial checklist. There are funds you may need to use before the year ends, budgets to assess, charitable donations to make, gifting limits to reach, and many more loose ends you may need to tie up.

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For Baby Boomers who are still working, there’s something else: Anyone 50 or older should assess whether to take advantage of the option to make catch-up contributions to a retirement plan prior to the end of 2011. Catch-up contributions are designed to help individuals nearing retirement accumulate savings at an accelerated rate.

Catch-up can be a confusing term because it sounds like investors are only eligible to make these contributions if they contributed a smaller amount of money in the past. Actually, there aren’t restrictions tied to past contribution levels or current account balances. Catch-up contributions simply apply to folks nearing retirement who’ve already maxed out the standard contribution limit and want to contribute more money to a retirement savings plan.

The Internal Revenue Service imposes limits on retirement plan contributions because these plans offer several tax-planning advantages. For example, employer-sponsored plan participants can make contributions on a pre-tax basis, meaning contributions reduce an employee’s taxable income. In addition, the account grows tax-free (i.e., no capital gains or regular income taxes) until you start taking withdrawals.

If you’re at least age 50, or if you’ll turn 50 before the end of 2011, you should be eligible to contribute extra catch-up money to a 401(k), a 403(b), the federal Thrift Savings Plan, and some other self-directed employer-sponsored retirement plans.

Regardless of the decisions you make for 2011, it’s wise, especially if you’re nearing retirement, to spend extra time mapping out a retirement savings strategy for 2012. Decide whether you can afford to contribute the standard limit and also take advantage of catch-up contributions. If there’s any way you can stretch your budget and max out your contributions each year, you’re making a tremendous investment in your own future.

This table shows IRS limits that apply to some common employer-sponsored retirement plans:

Type of Plan Calendar Year Standard Contribution Limit Catch-Up Contribution Limit Total Contribution Limit for Individuals 50+
Safe Harbor and standard
401(k);
403(b);
federal Thrift Savings Plan
2011 $16,500 $5,500 $22,000
Safe Harbor and standard
401(k);
403(b);
federal Thrift Savings Plan
2012 $17,000 $5,500 $22,500
SIMPLE 401(k) 2011 and 2012 $11,500 $2,500 $14,000

You may also be able to make catch-up contributions to an IRA. However, as with standard IRA contributions, there are some complicated limitations tied to household income. Income restrictions aside, IRA contribution limits for 2011 and 2012 are $5,000 for everyone, plus an additional $1,000 catch-up contribution for investors age 50 or older.

Catch-up contributions can be an excellent opportunity to strengthen your retirement savings and reduce your taxable income. As you undertake your year-end financial planning and make decisions about retirement plan contributions, remember to consult your tax professional.

Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal. Keep tabs on Scott on Twitter and Facebook.