Some Pointers for Building Up Nest Egg Savings
The concept was simple.
Older workers who hadn’t been able to save for retirement while they were starting careers and putting kids through college should be able to “catch up” on retirement savings by setting aside larger amounts in tax-deferred plans than other workers. Congress endorsed the idea in legislation passed in 2001 and is weighing another bill that would allow those 50 and older to save even more on a tax-deferred basis.
But integrating catch-up contributions into the complicated web of employee retirement plan design isn’t so easy.
Two years after the law passed, about 10% of plan sponsors still don’t allow employees to make the bigger catch-up contributions, said David Wray, president of the Profit Sharing/401(k) Council in Chicago.
The Internal Revenue Service issued final regulations this month in an attempt to answer some of the questions surrounding this employee perk. That may spur a few more firms to let their workers catch up on neglected retirement savings.
“I don’t think a lot of employees understand that even after the government passes a law, whether you can take advantage of it is sometimes up to the company,” said Ed Slott, a New York-based tax accountant.
“These new regulations could be big because it could cause some more companies to give their workers the opportunity to make catch-up contributions.”
Here’s a look at catch-up contributions and why some companies still aren’t allowing workers to take advantage of them.
Q: What are catch-up contributions?
A: These are additional contributions that workers 50 and older can make to tax-deferred retirement savings plans such as 401(k)s. The allowable maximum catch-up contribution varies by year and type of plan. Those with access to 401(k), 403(b) and 457 plans are able to save the most -- $12,000 in 2003, no matter their age, and an additional $2,000 for those who have reached the age of 50 and want to make catch-up contributions.
Those contributing to Simple plans and individual retirement accounts can’t save as much. The maximum ordinary contribution to a Simple plan is $8,000 in 2003. The Simple catch-up contribution limit is $2,000. Traditional and Roth IRA contributions max out at $3,000 a year, or $3,500 for those who are 50 and older.
Q: Why were catch-up contributions created?
A: There was concern that many middle-income parents in general and women in particular had failed to save in their younger years because they were spending their money on kids and college, or had taken time off from work to raise young children, said Lynn Dudley, vice president and senior counsel of the American Benefits Council in Washington.
At the same time, though the average worker contributes less than $4,100 annually to a 401(k), those who are closer to retirement often are willing and able to save considerably more, Dudley said. That’s mainly because many of their biggest expenses, such as buying first houses and paying for college, are behind them. Moreover, many stay-at-home spouses go back to work when the kids are grown, Dudley said. Catch-up contributions were designed to let these individuals sock away a lot of money in a hurry, making up for lost time.
Q: How much difference can catch-up contributions make?
A: Consider a hypothetical 50-year-old with a 401(k) account. If he or she contributed the maximum -- sans catch-up contributions -- for the next 15 years until retirement and the account earned an average of 7% a year, it would grow to $340,370 by retirement at age 65. Add in catch-up contributions, however, and the account grows by 30% to $444,045.
Q: Why don’t all companies offer catch-up contributions?
A: Two main reasons have to do with complicated “discrimination” tests with which retirement plan administrators must comply. These tests try to ensure that highly paid employees aren’t given preferential treatment under the retirement plan, such as being allowed to contribute relatively more of their salary than lower-paid workers.
Since older workers are more likely to have reached executive ranks and be earning more, some administrators thought allowing these individuals to save more through catch-up contributions would cause their plans to fail the discrimination tests. In its recent rulings, the IRS said this isn’t a problem: Catch-up contributions are exempted from those tests.
The other test is a more technical one, Wray said. It has to do with how some plans account for their retirement plan contributions. The IRS ruling didn’t help these plans, Wray said. They will either have to change the way they do their accounting or their workers will continue to be denied access to catch-up contributions.
Q: Is there anything you can do if your company doesn’t offer catch-up contributions?
A: Aside from urging your company to start a catch-up program, your only option is to consider saving for retirement outside of the company plan. One viable option for singles earning less than $95,000 or married couples earning less than $150,000 is to contribute to a Roth IRA. (Those earning more than these amounts are barred from making full Roth IRA contributions.) In 2003, a 50-year-old could contribute as much as $3,500 to a Roth. The maximum allowable contribution will rise to $4,500 in 2005 and to $6,000 in 2006.
Times staff writer Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes .com. For past Personal Finance columns visit The Times’ Web site at www.latimes.com/perfin.
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Playing catch-up
Workers 50 and older can make extra ‘catch-up’ contributions to tax-favored retirement plans, if their employers allow it. New IRS rules will make it easier for more companies to offer the catch-up option.
Maximum contributions for 401(k), 403(b) and 457 plans
*--* Contribution Catch-up
Year limit limit 2003 $12,000 $2,000 2004 $13,000 $3,000 2005 $14,000 $4,000 2006 $15,000 $5,000
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Maximum contributions for Roth and traditional IRAs
*--* Contribution Catch-up Year limit limit 2003 $3,000 $500 2004 $3,000 $500 2005 $4,000 $500 2006 $5,000 $1,000
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Source: CCH Inc.
