Traditional and Roth IRAs offer tax advantages that can help you maximize your retirement savings. If you’re age 50 or older, you have an additional opportunity to save more in a tax-advantaged IRA—”catch up” contributions. Catch-ups let you save up to $1,000 more of your earned income in your IRA. For 2014 and 2015 that’s a total of $6,500.
“Anytime you can save more for retirement and get tax advantages, we believe you should jump at the chance,” said Maria Bruno, a senior investment analyst with the Vanguard Investment Strategy Group.
The catch-up provision also applies to spouses age 50 and older. So if you file a joint return, both you and your spouse can each make a contribution even if only one of you has earned income. The maximum combined contribution is either your combined earned income or the IRA contribution limit, whichever is less. Unfortunately, not everyone takes advantage of this opportunity. An analysis of IRA contributions made by Vanguard clients indicates that some investors in the homestretch to retirement are contributing less than the maximum allowed, however the trend is improving.
“Overall, our data indicate investors over 50 are aware of the catch-up provisions as over half are doing so. That being said, we’ve seen a trend where investors don’t necessarily take advantage of the catch up in the year they turn 50 We’d like to see more individuals taking full advantage of the catch-up provision as soon as they are eligible to do so,” said Ms. Bruno.
Compounding can help power up catch-up contributions
Taking advantage of the catch-up provision could make a big difference in the size of your retirement nest egg over the long term.
If you invested an extra $1,000 annually in an IRA starting at age 50, you’d have an extra $20,800 (in today’s dollars) saved by age 65, assuming a hypothetical 4% return after inflation. The $20,800 would be composed of $15,000 in catch-up contributions plus $5,800 in earnings.
The value of catch-up contributions:
This example is hypothetical and doesn’t represent returns from any particular investment. Data source: Vanguard.
“This example illustrates that taking advantage of the IRA catch-up contribution can be a simple tool for tax-advantaged wealth accumulation,” said Ms. Bruno.
Another way to magnify the power of compounding is to delay your withdrawals. If you made your catch-up contributions as illustrated above and didn’t take any withdrawals until age 80, those 15 years of catch-up contributions would grow to $37,500, with $22,500 coming from compounding.
- All investing is subject to risk, including the possible loss of the money you invest.
- If you take withdrawals from an IRA before age 59½, you may have to pay ordinary income tax plus a 10% federal penalty tax. Note that the amount you convert to a Roth IRA is not subject to the 10% penalty.
- We recommend you consult an independent tax advisor for advice about your situation.