How 401k Catch-Up Contributions Work

One of the big questions retirement savers have been asking is how the age-50 and over catch-up contribution option works.

The rules are fairly straightforward, but there are a few nuances that are important to understand. The ultimate authority on the rules, as they pertain to you and your plan, is your benefits department.

Congress added the new catch-up contribution option to retirement plans out of concern that baby boomers hadn't been saving enough for retirement. This new option enable savers age 50 and over to increase contributions at a time when retirement draws near. Age-50 catch-up contributions are possible in 401k, 403(b) and 457 plans, and IRAs, but the rules differ among plans. This article focuses on 401k rules.

How It Works

The option works as follows, assuming your plan permits these contributions and you are age 50 or older: You may make an additional $5,000 pretax contribution to your 401k plan, on top of your regular pretax contribution limit. Starting in 2007, the $5,000 limit will be indexed to inflation (in $500 increments). By the way, the catch-up provision will expire along with the rest of the tax bill in 2011, unless Congress extends it.

The nice thing about the catch-up limit is that it is not subject to any other federal or plan contribution limits. Catch-ups are made on top of your current limits. After you contribute the maximum regular contribution ($15,000 for 2006) allowed for the year, you may make an additional catch-up contribution.

If your plan has restrictions that prevent you from contributing the maximum regular contribution ($15,000 for 2006), you can still make catch-up contributions on top of your other limit. This even holds true if your contributions are capped because you are considered a highly compensated employee (HCE). Indeed, the IRS is willing to let employers classify excess 401k contributions as catch-up contributions. So, if you are an HCE who is 50 or older, and your plan allows catch-up contributions, you should be able to contribute over your HCE limit without worrying about a refund.

Availability

One important thing to remember is that you can only make an age-50 catch-up contribution if your plan permits them. Over 90% of all plans allow catch-up contributions, but if you are unsure if your plan does, check with your benefits department.

The catch-up option is a great way to save additional dollars as your approach retirement, but as with most things, if you don't take advantage of the option, it will do you no good.